aoco 
K956m 


In  the  matter  of  terms  and  conditions  to  be 
prescribed  by  the  Commission  in  connection 
with  the  issuance  of  securities  under  Section  20a 
of  the  Interstate  Commerce  Act,  as  amended. 


The  Marketing  of 
American  Railroad  Securities 


INTRODUCTION 


The  Problem 


No  more  important  problem  today  challenges  the 
skill  and  wisdom  of  American  railroad  manage- 
ments— and  the  public  authorities  charged  with  the 
function  of  regulation — than  that  of  how  to  obtain  the 
capital  necessary  to  provide  the  facilities  required  to 
transport  the  commerce  of  our  growing  country. 

It  has  been  estimated  by  several  high  authorities  that 
in  order  to  meet  with  any  degree  of  adequacy  the  re- 
quirements for  new  construction,  for  additional  main 
tracks,  sidings,  and  yards,  for  equipment  and  terminal 
facilities,  for  elimination  of  grade  crossings,  especially 
in  the  larger  cities,  for  block  signaling  and  other  safety 
appliances,  and  the  requisite  general  strengthening  and 
improvement  of  existing  properties,  expenditures  are 
called  for,  aggregating  as  much  as  $1,000,000,000  a  year 
for  a  series  of  years  to  come. 

There  is  a  never-ceasing  demand  in  the  United 
States  for  more  and  better  railway  services.  Unless  this 
demand  is  to  remain  unsatisfied  the  railway  manage- 
ments must  find  some  v/ay  to  attract  to  the  railway 
industry  an  uninterrupted  and  steadily  augmenting  flow 
of  new  capital. 

The  problem  is  no  less  vital  to  the  public  whose  pros- 
perity and  convenience  so  largely  depend  upon  the  ade- 
quacy of  its  transportation  service.    At  the  same  time, 


Railroad 
Requirements 
for  Capital 
Aggregate 
Huge  Sum 
Yearly 


•''^**^*t'-2>0 


New  Railway 
Capital  Must  Be 
Attracted  From 
the  Savings  of 
the  People 


Existing  Method 
of  Disposing  of 
Railway 
S^'curities 


the  public  which  pays  the  rates  providing  the  return 
earned  upon  capital  invested  in  railroads,  has  a  clear 
interest  in  having  the  railroads  sell  their  securities — and 
obtain  their  new  capital — upon  terms  which  involve  no 
burden  upon  rates  beyond  that  actually  necessary  to 
attract  the  required  capital. 


Capital  already  invested  in  railroad  facilities  is  irre- 
vocably committed,  but  any  and  all  new  capital  must  be 
attracted  from  the  investing  public  upon  terms  and  un- 
der conditions  which  appeal  to  that  public. 

It  is  thus  of  essential  importance  that  the  following 
purposes  be  accomplished: 

1.  Obtain  the  capital. 

2.  Attract  it  upon  fair  and  reasonable  terms. 

3.  Have  a  broad  and  stable  market  for  railroad 
securities  and  a  favorable  disposition  on  the 
part  of  investors  toward  such  securities. 

Generally  speaking,  the  existing  method  of  disposing 
of  railroad  securities  is  by  three  processes: 

1.  Offering  stocks  pro  rata  to  existing  share- 
holders, the  issue  usually  being  underwrit- 

-    ten  by  bankers; 

2.  Selling  bonds  at  a  fixed  price  to  bankers, 
who  through  the  medium  of  a  syndicate  and 
with  the  cooperation  of  distributing  houses 
throughout  the  country,  market  them  to  the 
public;  and 

3.  Selling  an  issue  through  a  banker  to  the 
public,  with  a  commission  to  the  banker  for 
his  services.  (This  method  is  very  rarely 
employed. ) 


a 


The  question  is  now  raised  whether  it  would  be  well  ^^^  Proposed 

that  the  existing  practice  be  changed  and  that  railroad  ^j^g  ^    "Com- 

securities  hereafter   be  sold   by  one  of  the  following  petitive  Bidding" 
methods,  viz: 

1.  Unrestricted  public  bidding;  or 

2.  Competition  among  bankers. 

Such  a  change  would  of  course  involve  the  aban- 
donment of  the  heretofore  prevailing  method,  under 
which  a  railroad  company  usually  selects  a  banking 
house  of  high  standing,  and,  so  long  as  the  services  of 
that  banker  are  satisfactory,  makes  its  issues  of  securi- 
ties  customarily  through  or  with  the  aid  of  that  house. 

The  suggested  change  contemplates  that  the  relation- 
ship between  the  railroad  and  the  investment  market 
shall  be  similar  to  that  between  American  municipali- 
ties and  the  investment  market,  wherein  issues  of  securi- 
ties are  usually  sold  by  competitive  bidding. 

In  considering  this  problem,  the  paramount  question 
is :  How  can  it  be  made  certain  that  the  vast  amounts  of 
new  capital  required  by  the  railroads,  year  in  and  yesu* 
out,  shall  be  forthcoming  upon  the  most  advantageous 
terms? 


5 


I 

The  Existing  Practice  of 
Dealing  Through  Bankers 

A.     With  American  Railroads 

As  a  rule,  railroad  companies  of  the  United  States, 
like  those  of  other  countries,  market  their  bonds  by  sell- 
ing them  either  to  or  through  bankers.  In  cases  where 
securities  are  offered  for  pro  rata  subscription  to  stock- 
holders it  is  customary  for  the  corporation  to  protect 
itself  by  arranging  with  bankers  to  underwrite,  or  to 
form  a  group  to  underwrite,  their  sale,  that  is,  to  agree 
to  purchase  such  of  the  securities  as  are  not  taken  by 
the  stockholders. 

Most  of  the  important  railroad  companies,  as  well 
as  industrial  corporations,  make  a  practice  of  dealing 
with  a  particular  banking  house  or  a  particular  group 
of  bankers  in  marketing  securities.  This  relationship 
rarely  rests  on  formal  contract.  As  a  rule,  the  rela- 
tionship is  informal  and  tacit  and  its  duration,  as  will 
be  developed  in  detail  further  on,  depends  wholly  upon 
the  satisfaction  of  the  railroad  with  the  services  rendered. 
A  railroad  company  gradually  comes  to  recognize  a 
particular  banking  house  as  its  banker. 


The  existence  of  such  a  relationship  means  that  the 
railroad  has  at  its  disposal  continuously  the  services, 
skill,  standing,  experience,  advice  and  financial  influ- 
ence and  capacity  of  the  banker. 

Among  the  banker's  functions  are  to  keep  track  of 


The  Banker's 
Service 

Available  to  the 
llaili'oad 
Continually 


6 


Affiliation  With 
Bankers  Depends 
Entirely  on  Satis- 
factory Service 


Railroads 
Free  to  Change 
Their  Bankers 


the  financial  situation  and  requirements  of  the  railroad, 
to  assist  in  the  preparation,  in  advance  of  the  need,  of  a 
proper  and  serviceable  system  for  financing  such  re- 
quirements ;  to  advise  as  to  the  class,  kind  and  denomina- 
tion of  securities  to  be  issued  and  as  to  the  best  time  for 
selling  them,  so  that  his  clients  may  not  miss  an  oppor- 
tune moment  for  meeting  their  requirements;  to  indi- 
cate from  his  survey  of  the  markets  of  the  world  his  judg- 
ment as  to  the  amount  of  securities  which  could  be  ab- 
sorbed in  one  or  the  other  market;  to  scrutinize  the 
mortgages  and  deeds  of  trust  under  which  securities  are 
to  be  issued,  with  a  view  to  their  provisions  being,  on 
the  one  hand,  carefully  protective  of  the  investor,  and, 
on  the  other  hand,  sufficiently  broad  and  elastic  not  to 
hamper  and  restrict  the  corporation  unduly  in  respect 
of  its  future  requirements. 

The  terms  of  a  negotiation  are  by  no  means  imposed 
by  the  banker,  for  it  is  easily  within  the  means,  and  is 
recognized  as  an  important  and  responsible  duty,  of  those 
conducting  negotiations  on  behalf  of  the  railroad  com- 
pany, to  acquaint  themselves  with  the  reasonable  market 
value  of  the  securities  which  it  desires  to  sell  and  to  insist 
upon  obtaining  a  fully  adequate  price. 

The  railroads  for  whom  bankers  act  nowadays  can 
have  no  inducement  to  continue  that  affiliation  except 
satisfaction  with  the  services  rendered. 

A  railroad  company  generally  is,  and  akvays  ought  to 
be,  free  to  terminate  its  relationship  rdth  its  bankers  at 
any  time  and  entirely  within  its  own  discretion. 

That  changes  in  the  relationships  between  railroads 
and  bankers  do  occur  is  indicated  by  the  variations  which 
take  place  in  the  course  of  time,  in  the  connections,  and 


I 


the  relative  influence  and  position  of  the  prominent 
banking  firms  which  deal  in  railroad  securities. 

The  relationship  between  the  railroad  and  its  bankers 
is  one  which,  whilst  not  limiting  the  railroad's  freedom 
of  action  according  to  its  own  judgment  of  its  best  inter- 
est, does  involve  upon  the  part  of  the  bankers  certain 
definite  and  continuous  duties  and  obligations,  more 
fullv  referred  to  later  on. 


B.     With  Industrial  Corporations 

Industrial  corporations,  unlike  railway  companies 
subject  to  public  regulation,  are  entirely  free  to  sell 
their  securities  in  whatever  way  they  deem  most  ad- 
vantageous. Their  managers,  or  presidents,  are  very 
frequently  among  the  larger  stockholders,  and  indeed, 
in  numerous  cases,  are  the  principal  stockholders,  of  the 
respective  concerns,  and  therefore  have  a  more  direct 
and  important  pecuniary  stake  in  their  enterprises  than 
can  be  the  case  with  the  chief  executives  of  our  large 
railroad  corporations,  the  ownership  of  which  is  scat- 
tered in  the  hands  of  several  hundred  thousand  share- 
holders. 

Yet,  there  are  hardlj'-  any  industrial  concerns  either 
here  or  in  Europe  which  dispose  of  their  securities  by 
competitive  bidding  among  bankers  or  by  direct  offering 
to  the  public.  Practically  all  such  corporations  pursue 
the  course  of  negotiating  with  one  particular  banker  or 
group  of  bankers  and  entrusting  the  handling  of  their 
security  issues  to  such  banker  or  group  of  bankers  so 
long  as  their  services  prove  satisfactory.  Their  action 
is  conclusive  evidence  that  the  system  of  competitive 
bidding  is  found  unsuitable  and  disserviceable  by  the 
consensus  of  opinion  of  those  in  charge  of  industrial 
affairs,  here  and  in  Europe. 


Industries 

Here  and  Abroad 

Also   Deal    with 

Particular 

Bankers 


8 


Bankers   Buy 
Securities  for 
Distribution   to 
Investors 


II 

How  Railroad  Securities  Are  Placed 
With  the  Public 

The  great  complexity  involved  in  the  sale  of  securi- 
ties will  readily  be  seen  from  a  brief  outline  of  the 
method  usually  adopted  in  marketing  a  large  issue  of 
bonds.  The  railroad,  in  the  first  instance,  sells  the  issue 
to  a  strong  banking  firm  at  a  price  mutually  agreed  upon 
through  negotiation.  That  firm  then  associates  with 
itself  a  syndicate  consisting  of  many  (usually  hundreds) 
of  other  banking,  brokerage,  investment  and  distribut- 
ing houses  throughout  the  country,  each  having  its 
clientele  of  investment  customers. 

Bankers,  of  course,  do  not  buy  securities  for  perma- 
nent investment  by  themselves.  If  bankers  or  syndi- 
cates permanently  kept  the  securities  which  they  bought 
from  the  railroads  their  capacity  to  undertake  such 
transactions  would  be  exhausted  very  soon. 

If  securities  are  to  be  placed,  they  must  ultimately 
find  lodgment  with  investors,  and,  while  the  amounts 
of  securities  taken  by  large  investors,  such  as  the  life 
insurance  companies,  savings  banks  and  capitalists, 
appear  large,  their  aggregate,  especially  since  the 
advent  of  the  high  surtaxes,  is  small  compared  with  the 
investments  of  the  rank  and  file  of  small  investors. 


Pending  the  formation  of  a  syndicate,  the  firm  which 
has  contracted  with  the  railroad  stands  in  the  breach, 
and  is  responsible  to  the  railroad  whether  or  not  it  suc- 
ceeds in  forming  the  sjTidicate.  Even  after  the  forma- 
tion of  the  syndicate,  the  practice  is  that  the  responsi- 


9 


bility  of  the  contracting  firm  continues  and  it  remains 
liable  to  the  railroad  for  the  due  fulfillment  by  each 
syndicate  member  of  the  obligation  undertaken  by  him. 

Then  begins  the  laborious  process  of  selling  securities 
to  ultimate  investors,  through  advertising,  letters  and 
circulars  and  personal  presentation,  and  in  this  labor 
are  engaged  large  numbers  of  dealers  in  securities,  each 
with  his  own  clientele.  In  time,  if  the  issue  is  a  success, 
the  securities  are  absorbed. 

If  the  issue  is  not  a  success  the  participants  in  the 
syndicate  must  either  sell  the  securities  at  a  loss  or  carrv 
them  along  until  the  advent  of  propitious  times  enables 
them  to  dispose  of  them. 


The  selling  of  securities  to  the  public  has  in  recent 
years  undergone  a  radical  change.  Formerly,  the  prin- 
cipal buyers  of  railroad  bonds  were  wealthy  individuals 
and  large  corporations,  especially  insurance  companies 
and  savings  banks.  The  former,  owing  to  the  surtaxes, 
have  practically  been  eliminated  as  absorbers  of  railroad 
bonds  and  confine  their  investments  very  largely  to  tax- 
exempt  securities,  while  the  insurance  corporations  and 
savings  banks  do  not  invest  as  largely  as  before  the  war 
in  railroad  securities. 

It  has  therefore  been  found  necessary  to  discover  new 
channels  for  the  absorption  of  railroad  bonds.  This  has 
been  accomplished  within  the  past  few  years  by  a  most 
intensive  campaign  of  education  and  distribution  among 
the  rank  and  file  of  investors. 

The  result  has  been  exceedingly  gratifying  in  that  a 
vast  army  of  small  investors  has  been  developed.  The 
achievement  is  of  great  public  consequence  from  the 
social  and  economic  point  of  view. 


Securities  Not 
Taken  by- 
Investors  Must 
Be  Carried  by 
Syndicates 


Surtaxes  Have 
Practically  Elimi- 
nated Investment 
In  Railroad 
Securities 
By  Those  With 
Large  Incomes 


Vast  Anny  of 
Small  Investors 
Has  Been  Devel- 
oped by  Bankers 


10 


New  Proposal 

Involves 

Uncertainty 


III 

The  Proposal  to  Market  Railroad 

Securities  by  Competitive 

Bidding 

It  is  now  urged  in  certain  quarters  that  railroad  com- 
panies would  do  better  if  they  should  discontinue  deal- 
ing habitually  with  particular  banking  houses,  and, 
whenever  they  have  securities  to  sell,  would  offer  them 
for  sale  by  competitive  bidding  among  bankers,  regard- 
less of  past  affiliations. 

Some  even  go  so  far  as  to  advocate  that  bankers,  as 
such,  should  not  be  used  at  all,  not  even  upon  a  competi- 
tive basis,  but  that  the  railroad  companies  should  sell 
their  securities  directly  to  their  own  stockholders  or  to 
the  public  at  large,  preferably  offering  them  for  public 
tender  and  accepting  the  proposals  of  the  highest 
bidders.  

If  railroads  offered  bonds  direct  for  public  subscrip- 
tion in  limited  amounts,  the  result  might  be  fairly  satis- 
factory in  good  or  normal  times,  although  even  then, 
deprived  of  the  facilities,  the  skill  and  the  sponsorship 
of  responsible  bankers,  the  prices  obtained  would  prob- 
ably be  lower  than  those  which  would  have  been  realized 
by  dealing  with  a  banker,  and  that  consideration  takes 
no  account  of  the  uncertainty  in  which  the  railroad 
would  necessarily  find  itself  as  to  what  portion  of  the 
funds  it  required  would  be  in  fact  realized  as  the  result 
of  the  public  offering. 

Moreover  the  public  demand  would  naturally  con- 
centrate itself  upon  the  issues  of  the  best  known  and 


11 


most  prosperous  railroads,  making  it  very  difficult  for 
railroads  not  enjoying  high  credit  to  obtain  necessary 
funds, — all  the  more  difficult,  as  the  system  of  competi- 
tive bidding  \\^ould  offer  no  inducement  to  bankers  to 
take  upon  themselves  the  risk  and  responsibility  of  ac- 
quiring such  issues. 

Under  that  plan  there  would  likewise  be  less  assur- 
ance of  the  pursuance  by  railroads  of  a  sound  and  con- 
sistent financial  policy  such  as  a  prudent  and  conserva- 
tive banker  requires  as  a  basis  for  commending  securities 
to  the  confidence  of  the  investing  public  which  looks  to 
the  banker  for  advice  and  leadership. 

In  unfavorable  times,  of  course,  the  public's  response 
to  an  offering  of  securities  is  small,  at  times  exceeding- 
ly small.  It  occurs  frequently  that  bankers  or  syndicates 
have  to  carry  issues  of  bonds,  which  they  have  pur- 
chased, for  many  months  or  even  years,  until  investment 
demand  revives.  If  an  issue  of  bonds  offered  by  a  rail- 
road for  competitive  bids  on  direct  public  subscription 
resulted  in  non-success,  the  issue,  if  saleable  at  all,  could 
only  be  disposed  of  at  a  very  heavy  sacrifice. 

The  failure  of  a  public  offering  and  the  consequent 
public  knowledge  that  the  railroad  had  been  unable  to 
obtain  the  funds  it  requires,  would  cause  grave  damage 
to  a  railroad's  credit,  if  it  did  not  for  the  time  entirely 
destroy  it,  would  cause  alarm  amongst  investors,  and  in 
not  a  few  cases  might  cause  bankruptcy. 

That  is  the  vital  and  fundamental  difference  between 
the  risk  incurred  by  municipalities  and  that  incurred  by 
railroads  in  the  disposal  of  their  bonds  by  public  bid- 
ding. If  a  municipality  fails  to  dispose  of  its  bonds,  the 
situation  thereby  created,  though  embarrassing,  does  not 
ordinarily  involve  grave  harm,  and  can  be  dealt  with. 


The  Danger  of  a 
Less  Consistent 
Financial  Policy 


Failure  to  Dis- 
pose of  Issue 
Would  Impair 
Railroad  Credit 


12 

If  a  railroad  fails,  however,  the  damage  done  is  exceed- 
ingly grave  at  best — and  may  be  irremediable. 

The  "Public"  Does  Not  Bid 

As  a  matter  of  fact,  unrestricted  public  competition 
does  not  in  practice  mean  what  the  term  implies,  be- 
cause all  experience  has  shown  that  the  public  does  not 
care  for  such  bidding  and  actually  refrains  from  par- 
ticipating therein  to  any  appreciable  extent.  Even  in 
the  case  of  municipal  securities,  it  is  amply  demon- 
strated that  the  offerings  are  not  taken  by  the  public  in 
the  process  of  competitive  bidding,  except  in  a  very 
limited  measure.  The  successful  bidders  both  as  to 
quantity  and  price  are  almost  invariably  bankers  or 
banking  syndicates,  who  buy  for  resale  to  the  investor. 
Public  Relies  on  The  public  wisely  requires,  even  in  the  case  of  muni- 

Bankers'  Advice      cipal  Securities,  the  advice  and  moral  responsibility  of 

bankers.  They  want  to  be  sure  that  all  legal  matters 
have  been  properly  looked  into  by  somebody,  not  the 
seller,  and  that  the  soundness  and  validity  of  the  secur- 
ity is  vouched  for  by  a  competent  and  reliable  firm. 

If,  as  experience  has  shown,  the  public  cannot  be  de- 
pended on  to  cover  the  offering  even  of  municipal  bonds 
by  competitive  bidding,  this  would  be  so  in  a  still  more 
pronounced  degi-ee  in  the  case  of  railroad  securities.  It 
follows  that  public  competition  would  really  mean  not 
offering  securities  to  the  public,  but  offering  them  to  the 
bankers. 

The  banker,  if  he  were — as  he  would  be  in  this  case — 
entirely  free  to  bid  or  not  bid,  to  pick  and  choose,  to 
take  the  best  and  leave  the  less  good  alone,  would  actu- 
ally leave  the  less  good  alone,  with  the  result  that  many 
railroads  would  find  themselves  faced  with  the  grave 
consequences  of  the  failure  of  public  offerings. 


13 


Municipal  and  State  securities  possess  the  immense 
advantage  of  being  tax  free.  Yet  it  has  happened,  in 
the  past  quite  often,  and  even  not  unfrequently  of  more 
recent  dates,  that  such  issues  were  not  covered  when 
offered  for  public  bidding,  the  failure,  entire  or  partial, 
being  due  usually  to  their  being  unsuited  to  the  market 
or  because  of  some  doubt  as  to  their  legality.  Can  it  be 
doubted  that  the  same  result  would  occur  much  more 
frequently  in  the  case  of  railroad  securities  if  offered  for 
public  bidding? 


The  Experience  of  Cities 

It  is  true  that  government  and  municipal  securities 
in  this  country  are  usually  offered  for  competitive  bid- 
ding, but  government,  state  and  municipal  financing  is 
not  comparable  with  corporation  financing.  In  the  for- 
mer case  the  securities  based  upon  the  taxing  authority 
are  in  the  simplest  form — generally  little  more  than  a 
plain  promise  to  pay — and  in  recent  years,  since  the 
advent  of  high  surtaxes,  a  ready  market  is  usually 
assured  by  the  tax  exemption  feature. 

Nevertheless  public  officials  usually  deem  it  wise  to 
consult  bankers  before  determining  their  financial  poli- 
cies and  particularly  before  issuing  large  loans,  and  at 
times  have  sought  and  obtained  in  advance  informal 
guarantees  from  bankers  that  offerings  will  be  covered. 
They  can  of  course  rely  upon  bankers  rendering  assist- 
ance as  a  matter  of  civic  duty.  In  the  case  of  railroads, 
with  the  element  of  habitual  clientage  between  railroad 
and  banker  eliminated,  it  would  naturally  be  impossible 
to  count  upon  any  such  uncompensated  advice  and 
assistance. 


Public  Officials 
Consult  Bankers 
As  to  Issuing 
Large  Loans 


14 


Even  Municipal 
Offerings   Fail 
At  Times 


N.  Y.  City  Issues 
Often  Require 
Bankers'  Support 


As  illustrating  the  point  that  the  financing  of  state 
and  even  the  highest  grade  municipal  bonds  has  not  al- 
ways been  successful  in  spite  of  the  tax  exemption 
feature,  it  may  be  mentioned  that  in  June  and  August, 
1907,  the  City  of  New  York  offered  two  issues  of  bonds 
of  $29,000,000  and  $15,000,000,  respectively,  for  which 
bids  of  only  $2,100,000  and  $2,700,000,  respectively, 
were  received.  The  issues  were  sold  by  private  sale  to 
bankers  a  few  months  later. 

About  the  same  time  a  small  offering  of  bonds  by  the 
State  of  New  York  met  with  a  similar  result. 

In  1914,  shortly  after  the  outbreak  of  the  war,  the 
City  of  New  York,  finding  itself  in  immediate  need  of 
$100,000,000  of  gold  to  pay  notes  maturing  in  England 
and  France,  turned  to  J.  P.  Morgan  &  Company  and 
Kuhn,  Loeb  &  Company,  who,  without  compensation, 
as  a  matter  of  public  duty,  undertook  to  organize,  and 
in  the  midst  of  conditions  of  unprecedented  difficulty, 
did  organize  a  syndicate  to  provide  the  necessary  funds. 

In  more  than  one  instance  in  the  years  preceding  that 
occurrence,  the  City  was  compelled,  in  order  to  avoid 
failure  of  an  issue  offered  for  public  tender  for  the  pur- 
pose of  meeting  pressing  requirements,  to  have  recourse 
to  one  or  the  other  of  the  leading  banking  houses.  In 
numerous  cases,  it  was  only  large  subscriptions  by  such 
banking  houses — made  often  without  any  expectation 
of  profit  and  resulting  none  too  rarely  in  losses — which 
avoided  the,  at  least  partial,  failure  of  public  offerings 
of  the  bonds  of  the  City  of  New  York. 


There  is  no  reason  to  believe  that  the  cities  have  been 
better  off  under  the  practice  of  selling  bonds  at  public 
offering  to  the  highest  bidders  than  they  would  have 


15 


been  had  they  been  permitted  to  deal  privately  with  the 
bankers  as  do  the  railroads.  But,  even  if  it  were  other- 
wise, it  is  manifest  that  railroad  companies  could  not 
possibly  expect  to  fare  as  well  as  do  the  municipalities 
if  they  had  to  de^Dend  upon  the  uncertain  and  fluctuat- 
ing public  demand  when  they  attempt  to  sell  their  se- 
curities at  public  offering  to  the  highest  bidder. 

Especially  does  this  hold  true  in  the  case  of  the  less 
strong  railroads,  where  a  careful  analysis  and  study  of 
the  condition  of  the  company  and  sometimes  even  an 
auditor's  or  an  expert's  report  is  required  before  a  con- 
servative banker  will  stand  sponsor  for  the  company's 
securities.  The  investing  public  will  neither  take  the 
trouble,  nor  does  it  possess  the  qualifications,  to  analyze 
for  itself  the  position  of  the  securities  of  the  less  well- 
known  properties  and  to  form  a  reasoned  estimate  as  to 
their  degree  of  safety,  based,  as  such  estimate  must  be, 
upon  the  compilation  and  study  of  statistical  and  other 
data,  which  it  is  among  the  functions  of  the  banker  to 
gather  and  to  make  available  to  his  investment  clients 
in  convenient  and  easily  understood  form. 

In  this  connection  it  is  significant  that  the  Farm  Loan 
Bureau  of  the  United  States  Treasury  has  found  it  ad- 
vantageous to  issue  the  bonds  of  the  Farm  Loan  banks 
not  by  competitive  bidding  but  through  a  group  of  bank- 
ers selected  by  the  Bureau  whom  it  may  at  all  times  feel 
free  to  consult  and  who  watch  the  markets  in  the  interest 
of  the  Bureau. 


Competitive 
Bidding  Would 
Bring 

Uncertainty  In 
Railroad 
Financing 


United  States 
Farm  Loan 
Bureau  Relies 
On  Bankers' 
Services 


European  Practice 


In  not  a  single  European  country  does  the  system 
prevail  of  competitive  sale,  either  general  or  limited,  of 
securities  on  the  part  of  corporations.    Moreover,  many 


16 


Dealing  With 
Selected  Bankers 
Still  Continues 
Abroad 


even  of  the  Governments  and  Municipalities  in  placing 
their  loans,  have  recourse  not  to  competitive  bidding  but 
to  regularly  established  and  continuous  connections  with 
a  banking  house  or  a  group  of  banking  houses.  Not  one 
of  the  foreign  Governments,  belligerent  or  neutral, 
which  during  the  European  war  have  found  access  to 
the  American  investment  market  for  the  securities  of 
their  respective  countries,  had  recourse  to  competitive 
bidding  amongst  bankers  or  otherwise.  In  each  instance 
the  Government  concerned  has  dealt  with  some  one  par- 
ticular banker  or  group  of  bankers  whom  it  selected  as 
efficient  and  worthy  of  confidence. 

A  cabled  inquiry  addressed  within  a  week  to  eight 
different  countries  in  Europe,  and  also  to  Japan,  to  find 
out  whether,  since  the  war,  the  practice  has  been  modi- 
fied in  those  countries  of  dealing  with  selected  bankers 
for  the  sale  of  public  service  and  other  corporate  securi- 
ties and  even,  in  numerous  cases,  governmental  or  muni- 
cipal bonds,  elicits  the  information  that  no  reason  has 
been  found  to  change  that  practice  and  that  it  continues 
to  prevail. 


17 


IV 

The  Present  Method  of  Under- 
writing the  Sale  of  Stocks 
to  Shareholders 

Under  the  laws  of  most  states  and  the  charters  of 
most  corporations,  it  is  necessary  that  new  issues  of 
stock,  or  of  bonds  carrying  the  privilege  of  conversion 
into  stock,  must  first  be  offered  for  pro  rata  subscription 
to  the  corporations'  stockholders.  In  such  cases  the 
banker's  knowledge  of  markets  is  valuable  to  advise  the 
corporation  of  the  character  of  securities  which  its  share- 
holders are  likely  to  accept  or  for  which  the  subscrip- 
tion rights  would  command  a  market  value. 

When  an  offering  of  new  stock  is  made  to  sharehold- 
ers of  a  corporation  it  creates  a  technically  weak  market 
position,  inasmuch  as  both  the  existing  stockholder  and 
the  speculator  know  that  there  is  a  mass  of  new  stock 
about  to  issue,  and  the  market  must  absorb  it.  Conse- 
quently the  speculator  is  apt  to  incline  towards  rushing 
into  the  market,  arguing  to  himself:  "I  will  sell  that 
stock.  I  will  get  it  back  cheaper.  The  market  must 
absorb  such  and  such  a  number  of  millions  of  new  stock, 
and  it  cannot  do  that  without  going  down.  I  am  quite 
safe  in  selling  some." 

Experience  has  shown  that  in  many  cases  the 
stockholder  to  whom  the  so-called  right  to  subscribe  for 
new  stock  is  offered,  does  not  exercise  that  right.  He 
is  not  always  prepared  to  put  up  additional  cash.  He 
frequently  sells  his  "rights"  for  whatever  may  be  their 
market  value. 


New  stock  Offer- 
ing Creates 
Technically  Weak 
Market  Position 


18 


Underwriting 
Guarantees  Suc- 
cess and  Protects 
Security  Values 


Consequently,  by  the  very  issue  of  additional  stock, 
offered  to  existing  stockholders,  there  is  created  an  un- 
favorable and  somewhat  hazardous  market  condition. 
Naturally,  the  tendency  invariably  is  for  the  offering  of 
stock  to  depress  the  existing  level  of  the  stock.  That 
may  go  so  far  as  to  remove  any  inducements  to  the  stock- 
holder to  subscribe  for  the  new  stock,  and  to  render 
"rights"  valueless.  An  unprotected  offering,  i.  e.,  an 
offering  not  protected  by  underwriters,  is  a  target  for 
selling. 

Moreover,  not  to  mention  the  damage  to  its  credit  in 
case  of  the  failure  of  such  an  offering,  the  railroad  is  un- 
certain pending  the  time  in  which  the  securities  are  under 
offer  to  the  stockholders  (usually  not  less  than  from  45 
to  60  days)  whether  or  not,  or  to  what  extent,  the  stock- 
holders will  subscribe,  and  is,  consequently,  in  doubt 
whether,  at  the  end  of  the  subscription  period,  it  will 
come  into  possession  of  the  funds  it  requires. 

All  of  this  is  obviated  by  the  formation  of  an  under- 
writing syndicate  inasmuch  as  it  guarantees  to  take  and 
pay  for  any  part  of  the  offering  which  the  stockholders 
may  not  want  to  take.  The  existence  of  such  a  syndi- 
cate and  the  resulting  guarantee  of  the  success  of  the 
offering  has  a  strong  moral  effect  upon  the  stockholders 
in  encouraging  them  to  subscribe,  and  an  equally  strong 
effect  in  discouraging  speculators  from  "short  selling" 
while  an  unprotected  offering  invites  such  selling. 

It  follows  that  a  railroad  can  safely  afford  to  offer 
securities  at  a  much  higher  price  when  underwiitten 
than  they  would  risk  flawing  when  not  secured  and  jiro- 
tected  by  an  underwriting. 

A  characteristic  illustration  of  the  foregoing  is  fur- 
nished by  the  experience  of  the  Pennsylvania  Railroad 


19 


Companj^  than  which  there  is  no  stronger  railroad  cor- 
poration in  the  country,  when  in  1903,  it,  without  under- 
writing, offered  $75,000,000  of  its  stock  for  subscription 
by  its  stockholders  at  120%.  The  market  price  of  the 
stock  at  the  time  was,  and  for  some  time  had  been, 
around  145%.  Owing  to  the  large  difference  between 
the  market  price  and  the  price  of  the  offering,  the  offi- 
cers and  directors  of  the  railroad  deemed  it  unnecessary 
to  insure  success  by  an  underwriting. 

As  a  result  of  changes  in  market  conditions,  sales  of 
rights  by  stockholders  and  selling  by  speculators,  it  be- 
ing known  that  there  was  no  underwriting  syndicate, 
the  market  value  of  the  stock  rapidly  declined.  When 
the  price  in  its  descent  had  reached  125^4  and  the  failure 
of  the  offering  appeared  imminent,  the  railroad  finally 
called  upon  its  bankers  to  form  a  syndicate  to  underwrite 
the  issue,  which  was  promptly  done.  The  reassuring 
effect  of  the  mere  public  announcement  that  a  syndicate 
had  guaranteed  to  take  and  pay  for  any  part  of  the 
offering  which  was  not  subscribed  for  by  the  stockhold- 
ers, was  such  as  to  arrest  immediately  the  selling  on  the 
part  of  alarmed  stockholders  as  well  as  by  speculators. 
The  decline  in  the  market  stopped,  and  a  threatened 
failure,  which  might  have  involved  serious  consequences 
and  affected  railroad  credit  generally,  was  turned  into 
a  complete  success. 


Even  after  taking  into  consideration  the  expense  of 
an  underwriting  syndicate,  a  railroad  will  usually  obtain 
materially  higher  net  proceeds  from  an  underwritten 
offering,  than  from  one  not  underwritten,  in  addition  to 
the  advantage  of  being  certain  of  securing  the  required 
funds. 


The  Hazai'd 
Exeniplified  iu  a 
Pennsylvania 
Railroad 
Experience 


The  Plan  of 
Underwriting 
Usually  Assures 
Better  Terms  and 
Higher  Prices 


20 


Actual  Expe- 
rience With 
Direct  Offerings 


Manifestly,  it  is  more  advantageous  to  a  railroad's 
financial  position  and  the  maintenance  of  the  price  level 
of  its  securities  to  offer  a  security,  even  to  its  stock- 
holders, at  say  110,  and  pay  a  reasonable  underwriting 
commission,  rather  than  to  offer  it  at  par  without  an 
underwriting. 

The  cases  in  which  railroad  companies  or  other  cor- 
porations have  successfully  sold  their  securities  direct  to 
the  investor  are  exceedinglj^  rare,  and  even  then  usually 
at  prices  below  what  could  have  been  obtained  from 
bankers. 

To  quote  only  one  example  of  non-success  in  the  case 
of  direct  dealing  with  the  public,  the  Vermont  Valley 
Railroad  in  1914  offered  for  competition  by  sealed 
tenders  an  issue  of  $2,300,000  of  its  6%  one-year  notes. 
Although  the  Vermont  Valley  Railroad  was  a  very  pros- 
perous concern,  having  a  record  at  that  time  of  having 
paid  dividends  at  the  rate  of  lO^o  per  annum  for  nine 
years,  and  the  notes  had  the  additional  security  of  being 
guaranteed  by  the  Connecticut  River  R.  R.  Co.,  the 
offering  resulted  in  complete  failure,  practically  no  bids 
having  been  received. 

On  the  other  hand,  the  case  of  the  American  Tele- 
phone and  Telegraph  Company  which  recently  sold  a 
large  issue  of  stock  at  par  directly  to  its  stockholders, 
without  the  intermediation  of  bankers,  has  been  cited  as 
significant  and  indicative  of  the  possibilities  of  effective 
results  without  the  co-operation  of  bankers.  The  real 
significance  in  that  case,  however,  lies  in  the  patent  fact 
that  had  that  issue  been  underwritten  by  bankers  a  con- 
siderably higher  price  for  the  company  could  have  been 
obtained.  The  security  sold  by  the  American  Tele- 
graph and  Telephone  Company  was  seasoned  stock  pay- 


21 


ing  9%  dividends.  It  was  offered  at  par.  Bankers, 
in  consideration  of  a  reasonable  commission,  would 
gladly  have  underwritten  the  offering  at  a  considerably- 
higher  price.  It  should  be  understood  that  this  does  not 
imply  any  suggestion  of  criticism  as  to  the  course  pur- 
sued by  the  Company.  There  were  valid  considerations 
of  broad  policy  which  guided  the  decision  of  those  in 
responsible  charge,  to  give  to  the  vast  body  of  its  stock- 
holders the  benefit  of  a  stock  offering  at  a  particularly 
attractive  price. 


22 


The  Pressure  of 
Stockholders 
Upon  Directors 
for  Best  Results 
Is  Important 


V 

Effective  Competition  Prevails 
Under  Present  Methods 

There  are  ever  present  elements  of  actual  or  potential 
competition  which  assure  favorable  terms  to  a  railroad 
company  dealing  habitually  with  the  same  bankers. 

The  price  and  the  margin  of  profit  or  commission  at 
which  a  banker  concludes  a  negotiation  with  a  railroad 
company  for  its  securities  is  necessarily  in  competition 
with  the  terms  upon  which  other  bankers  negotiate  with 
other  railroad  companies  for  their  securities. 

The  prices  at  which  railroads  sell  their  securities  are 
now  matters  of  public  record.  Moreover,  the  terms  of  a 
contract  between  the  railroad  and  the  banker  are  subject 
to  the  approval  of  the  Interstate  Commerce  Commis- 
sion. No  banker  expecting  to  maintain  his  regular  con- 
nection with  a  railroad  company  can  do  otherwise  than 
pay  full  and  fair  value  for  the  securities  which  it  has  to 
sell.  It  is  a  matter  of  necessity  and  self-interest  for  him 
to  do  so. 

Railroad  companies,  through  various  means,  are  well 
able  to  place  an  accurate  estimate  upon  the  market  value 
of  securities  which  they  have  for  sale,  and  no  board  of 
directors  could  afford  to  incur  the  opprobrium  and  re- 
sponsibility of  selling  securities  to  their  regular  banking 
connections  otherwise  than  on  the  basis  of  what  they 
are  reasonably  and  fairly  worth,  considering  the  time 
and  the  conditions. 

The  prevailing  market  prices  of  existing  issues  fix 
very  closely  the  prices  at  which  new  securities  can  be  sold 
to  investors.     The  banker  who  would  make  a  practice 


23 


of  marketing  the  securities  of  his  clients  at  prices  mate- 
rially below  the  prevailing  prices,  for  issues  of  similar 
character  and  quality  would  soon  lose  his  clients. 

In  isolated  instances,  for  the  purpose  of  obtaining 
advertisement  or  position,  or  even,  in  certain  instances, 
for  reasons  of  a  less  legitimate  kind,  others  than  the 
regular  banking  connections  of  particular  railroads  may 
conceivably  be  willing  to  pay  a  somewhat  higher  price 
for  an  issue  of  securities  than  such  regular  connections ; 
but  there  is  no  reason  whatever  to  think  that  such  "occa- 
sional" bidders  would  be  able  or  willing  to  do  better  for 
the  railroads,  year  in  and  j^ear  out,  than  the  bankers 
usually  acting  for  those  railroads.  On  the  contrary, 
there  is  every  reason  to  expect  the  reverse. 


Importance  of 
Regarding 
Results  In  the 
Long  Run 


Whether  through  a  system  either  of  unrestricted  pub- 
lic bidding  or  of  competitive  bidding  limited  to  bankers, 
the  railroads  year  in  and  year  out  would  obtain  higher 
prices  for  their  securities  than  have  been  and  are  being 
realized  under  the  existing  time-tested  system,  is  a  mat- 
ter of  opinion  and  cannot  be  anything  else.  Whether 
that  opinion  is  pro  or  con,  there  can  be  no  question  that 
as  against  gaining  a  wholly  problematical  and  uncertain 
benefit  the  railroads  stand  to  lose  the  certain,  well-es- 
tablished and  weighty  advantages  which  now  accrue  to 
them  through  the  responsibility  and  moral  and  practical 
obligations  toward  them  of  the  bankers  with  whom  they 
habitually  deal. 

To  market  railroad  securities  on  a  large  scale  requires 
a  combination  of  skill,  experience,  capital,  reputation 
and  connections  that,  from  the  nature  of  the  case,  can  be 
possessed  by  only  a  limited  number  of  concerns  at  any 


What  Is  Required 
of  A  Banker 


24 


Ability  To 
Market  Securities 


one  time,  because  only  the  test  of  time  will  produce  most 
of  these  necessary  qualities. 

That  skill,  experience  and  reputation  it  is  the  business 
of  the  banker  to  make  available  to  his  clients,  together 
with  his  financial  potency  and  relationships. 

A  banker  of  long  experience  with  a  record  of  success, 
conservatism  and  integrity,  develops  a  jjower  to  place 
securities  that  is  of  great  value  to  his  clients,  cumulative- 
ly so  the  longer  the  relationship  is  maintained. 


Past  Year  No 
Criterion  of 
Normal  Market- 
ing Conditions 


Results  Must  be  Judged   Over  Period   Covering 
Both  Rising  and  Declining  IMarkets 

The  question  of  the  best  and  most  serviceable  method 
of  selling  railroad  securities  must  be  determined  not 
from  the  wholly  exceptional  and  fortuitous  circum- 
stances which  have  prevailed  during  the  last  year,  but  in 
the  light  of  the  experience  of  the  longer  past  and  the 
needs  of  the  future. 

In  the  marketing  of  securities,  as  in  other  businesses, 
there  are  occasional  periods  of  excessive  activity,  usu- 
ally of  comparatively  short  duration,  occasional  periods 
of  acute  depression  and  longer  periods  of  normal  ac- 
tivity. 

It  happens  that  this  year  has  been  a  period  of  un- 
paralleled activity  in  the  marketing  of  securities  of  do- 
mestic issues,  simultaneously  Mdth,  and  partly  caused 
by,  growing  reluctance  to  invest  in  issues  of  European 
countries.  There  has  been  a  vast  and  almost  insatiable 
demand  for  new  domestic  securities,  particularly  bonds, 
an  almost  uninterrupted  decrease  in  interest  rates  and 
a  corresponding  increase  in  the  market  value  of  securi- 
ties. 


25 


The  result  has  been  that  bankers  and  syndicates  have 
been  much  more  than  usually  successful  in  marketing 
the  domestic  security  issues  which  they  have  purchased 
and  that  as  a  rule  new  security  issues  have  advanced  in 
the  market  and  reached  prices  in  excess  of  the  issue 
price.  The  upward  trend  of  security  values  is  illus- 
trated by  the  fact  that  in  the  last  ten  months  the  average 
market  price  of  ten  standard  railroad  bond  issues  taken 
at  random  has  increased  about  thirteen  points. 

It  has  been  a  time  when  it  was  possible  to  indulge  in 
improvident  bidding  or  "spite-bidding,"  without  being 
deterred  by  the  swift  penalty  of  non-success  in  market- 
ing, which  follows  such  practices  under  normal  circum- 
stances. 

Under  these  conditions,  it  is  easy  for  critics  who  con- 
sider only  recent  experience,  and  whose  knowledge  does 
not  cany  them  back  to  the  pre-war  years  (which,  after 
all,  furnish  the  best  standards  for  judging  the  future) , 
to  jump  at  the  conclusion  that  the  railroads  have  not 
been  receiving  the  best  possible  prices  for  the  securities 
the}''  have  marketed  and  that  higher  prices  would  have 
been  reahzed  if  the  sale  of  railroad  securities  had  been 
opened  up  for  competition. 

Criticism  has  been  especially  easy  and  abundant  on 
the  part  of  those  who  have  little  or  no  background  of 
experience  in  the  marketing  of  railroad  securities  to 
guide  them,  who  have  not  had  to  bear  the  responsibility 
of  financing  the  requirements  of  great  railroad  proper- 
ties in  normal  times  and  during  periods  of  depression 
and  who  do  not  realize  the  necessity  of  looking  ahead  to 
the  future  periods  of  depression  or  of  more  normal  de- 
mand for  securities  when  the  railroads  of  the  country 
will  have  the  same  need  for  new  capital  as  now. 


Recent  Period 
No  Safe 

Guide  for  General 
Procedure 


26 


How   All   Under- 
writing Syndi- 
cate Averted 
Failure  of 
$100,000,000 
Bond  Issue 


VI 

Present  Procedure  Has  Proved  of 
Advantage  to  the  Railroads 

To  deal  through  bankers  in  accordance  with  present 
practice,  has  actually  proved  itself  a  source  of  dis- 
tinct financial  advantage  to  railroads — even  the  most 
prosperous  and  soundly  financed  companies. 

A  few  conspicuous  cases  may  be  cited  here  to  illustrate 
the  point:* 

1.  In  March,  1905,  the  Pennsylvania  Railroad  ar- 
ranged with  its  bankers  to  form  a  syndicate  to  underwrite 
the  offer  to  its  shareholders  at  par  of  $100,000,000 
Pennsylvania  Railroad  3^2  per  cent  Convertible  Bonds 
(convertible  into  stock  at  150  percent).  The  stock- 
holders subscribed  for  less  than  10  per  cent  of  the  offer- 
ing and,  consequently^  the  underwriting  syndicate  had 
to  take  and  pay  for  about  $90,000,000  of  the  bonds. 
The  bonds  within  the  year  declined  to  97%  P^r  ^^^^ 
and  never  again  reached  par,  the  price  at  which  they 
were  first  offered. 

If  it  had  not  been  for  the  underwriting  syndicate,  the 
situation,  resulting  from  the  failure  of  the  stockholders 
to  subscribe  and  thus  provide  the  money  needed  by  the 
railroad,  would  have  been  very  embarrassing  to  the  rail- 
road and  very  serious  in  its  effect  upon  the  general 
financial  and  investment  situation  of  the  country. 


♦  A  number  of  additional   instances  of  a   similar  value   to   the 
railroads  will  be  found  on  pages  33  to  37. 


27 


2.  In  1908,  a  situation  had  arisen  which  had  brought 
the  market  for  railroad  bonds  in  this  country  to  a  com- 
plete standstill.  Railroads  for  many  months  were  un- 
able to  obtain  funds,  except,  to  a  limited  extent,  by 
means  of  the  costly  and  dangerous  expedient  of  selling 
short  term  notes.  The  effect  was  cumulative  and  far- 
reaching  and  threatened  to  bring  about  serious  conse- 
quences. At  this  juncture  the  bankers  of  the  Pennsyl- 
vania Railroad  succeeded  in  inducing  the  two  foremost 
banking  houses  in  England,  Messrs.  N.  M.  Rothschild 
&  Sons,  and  Messrs.  Baring  Brothers  &  Co.,  Ltd.  (the 
former  of  whom  had  not  issued  an  American  security 
for  many  years) ,  to  purchase  and  bring  out  jointly  with 
them  at  96  per  cent  an  issue  of  $40,000,000  Pennsyl- 
vania Railroad  4  per  cent  Consolidated  Bonds. 

Largely  in  consequence  of  the  prestige  and  placing 
power  and  investment  following  of  the  issuing  houses, 
the  public  offering  was  a  complete  success  and  its  effect, 
as  recognized  by  many  published  comments  here  and 
abroad,  was  to  break  the  deadlock  which  had  existed, 
and  to  cause  capital  to  flow  again  freely  into  the  invest- 
ment market. 

3.  In  August,  1913,  bankers  formed  a  syndicate  to 
underwrite  the  offer  to  Union  Pacific  stockholders  of 
$88,000,000  Southern  Pacific  Stock  Trust  Certificates 
at  92  per  cent.  The  effectuation  of  that  sale  was  of  very 
great  importance  as,  failing  it  by  a  certain  very  near 
date,  the  Southern  Pacific  stock  in  question  would  have 
been  placed,  under  a  court  decree,  in  the  hands  of  a 
receiver,  the  sentimental  and  actual  effect  of  which 
course  would  have  been  grave. 

In  the  face  of  many  predictions  that  a  syndicate  to 
guarantee  the  sale  of  so  vast  an  amount  of  stock  could 


Pennsylvania 
Bond  Flotation 
In  1908  Broke 
Investment 
Deadlock 


28 


United  States 
Attorney-General 
Required  Under- 
writing U.  P.- 
S.  P.  Dissolution 
Sale 


not  be  formed  under  the  then  prevailing  generally  dis- 
turbed and  unfavorable  conditions,  the  bankers,  with  the 
aid  of  their  connections  throughout  America  and 
Europe,  succeeded  in  the  undertaking,  the  syndicate  as 
finally  made  up  consisting  of  nearly  a  thousand  partici- 
pants. It  is  entirely  safe  and  well  within  bounds  to 
say  that  if  that  mass  of  stock  had  been  offered  without 
guarantee  and  protection  of  an  underwriting  syndicate, 
it  would  not  have  been  sold — if  at  all,  within  the  time 
limit  set  by  the  court — at  a  price  averaging  better  than 
80  per  cent. 

4.  In  connection  with  the  first  plan  for  the  dissolu- 
tion of  the  Union  Pacific-Southern  Pacific  combination 
approved  by  Attorney-General  Wickersham  (which 
failed  of  adoption  because  of  the  refusal  of  the  Cali- 
fornia Railroad  Commission  to  approve  certain  of  its 
features),  he  imjjosed  the  condition  that  the  sale  of  the 
Union  Pacific  Company's  holdings  of  Southern  Pacific 
stock  (which  would  be  offered  for  pro  rata  purchase  to 
the  stockholders  in  the  Southern  Pacific  Company) 
should  be  underwritten  by  a  syndicate. 

He  imposed  that  condition  for  the  manifest  reason 
that  the  sale  of  the  stock,  however  attractive  the  price  to 
the  stockholders  might  be,  could  be  insured  only  in  case 
definite  arrangements  were  made  for  a  sale  of  the  stock 
that  might  not  be  taken  by  the  stockholders  upon  the 
offering. 

None  of  the  aforementioned  transactions,  under  the 
circumstances  of  the  cases  and  the  times,  could  have 
been  effected  equally  well,  if  at  all,  by  any  method  of 
competitive  negotiating  or  bidding. 


29 


VII 

The   Payment  to  the   Banker  is  for 

Assuming  a  Substantial  Risk  and 

Performing  a  Valuable  Service 

The  risk  taken  by  the  banker  and  the  syndicates  he 
may  organize  is  always  a  real  and  at  times  a  very  great 
one.  There  is  widespread  misapprehension  as  to  the 
profits  made  by  bankers  and  syndicates  upon  the  under- 
writing and  purchase  of  securities  of  railroad  companies. 

There  is  also  a  frequently  encountered  misconception 
to  the  effect  that  the  railroads  are  in  the  habit  of  paying 
a  commission  to  the  banker  when  selling  securities  to 
him. 

When  the  banker  forms  a  syndicate  to  underwrite  an 
offer  of  securities  to  shareholders  a  fixed  commission  is 
naturally  stipulated,  commensurate  with  the  advantage 
secured  by  the  railroad  company  in  obtaining  through 
the  underwriting  the  certainty  of  the  success  of  its  offer- 
ing, and  with  the  risk  incurred  by  the  banker  and  the 
syndicate  affiliated  with  him. 

On  the  other  hand,  in  the  case  of  the  sale  of  railroad 
securities  to  or  through  bankers  without  an  offering  to 
stockholders,  it  is  very  unusual  for  the  sale  to  be  on  a 
commission  basis.  As  a  rule,  the  procedure  is  that  the 
banker  makes  a  firm  bid  to  the  railroad  for  such  securi- 
ties at  a  fixed  price,  said  price  with  the  addition  of  a 
reasonable  standardized  percentage  for  his  own  com- 
pensation being  the  figure  at  which  he  expects  to  be  able 
to  form  a  syndicate.  That  compensation  is  in  return 
for  his  preparatory  work,  his  moral  and  actual  responsi- 


Bankers'  Re- 
muneration for 
Risk  and  Services 
Involved 


Bankers  Usually 
Buy  Securities 
From  A  Railroad 
At  A  Fixed  Price 


30 


Bankers'  Charge 
A  Fixed  Per- 
centage 


Risk  Does  Not 
End  Witli  the 
Formation  of 
A  Syndicate 


The  Bankers' 
Responsibility 
To  the  Syndicate 


bility  and  risk  and  his  services  in  managing  the  syndi- 
cate.   It  is  a  charge  made  by  the  banker  to  the  syndicate. 

The  compensation  of  the  banker  and  the  anticipated 
profit  of  the  syndicate  are  practically  a  fixed  percentage. 
The  banker's  method  is  not,  to  buy  low  and  sell  high. 
In  fixing  the  selling  price  to  the  public,  he  merely  adds 
to  the  purchase  price  a  certain  percentage  to  cover  his 
own  and  his  syndicate's  compensation  and  expenses,  and 
that  percentage  does  not  vary  materially  irrespective 
of  whether  the  purchase  price  was  say  90%  or  95%  or 
1007o. 

His  aim  and  inducement  are  to  buy  at  a  price  which 
will  enable  the  securities  to  be  sold  to  the  public  after 
adding  to  that  price  the  customary  compensation.  He 
has  no  inducement  whatever  to  buy  at  a  lesser  price,  be- 
cause his  compensation  would  n^t  he  increased  thereby, 
but  on  the  other  hand  the  good  will  and  approval  of  the 
railroad  concerned  would  be  jeopardized. 

When  a  syndicate  is  formed  the  banker's  financial 
risk  is  by  no  means  ended,  as,  in  practically  all  cases,  he 
is  himself  a  large  participant  in  the  syndicate — is,  in 
fact,  expected  to  be.  Moreover,  generally,  he  remains 
financially  responsible  to  the  railroad  for  the  commitment 
of  each  individual  syndicate  participant.  The  railroad 
looks  to  him  for  the  due  performance  of  the  contract, 
and  not  to  the  hundreds  of  syndicate  members. 

Again,  his  moral  risk  and  responsibility  towards  the 
syndicate  is  great,  inasmuch  as  he  is  relied  upon  by  its 
members  to  have  examined  carefully  into  the  sound- 
ness of  the  security,  to  have  scrutinized  the  mortgage, 
to  have  taken  competent  legal  advice,  to  have  correctly 
gauged  the  moment  and  estimated  the  price  at  which 
the  securities  can  be  advantageously  placed  with  the 


31 


public,  to  do  the  principal  work  in  marketing  them,  and 
to  guide  the  work  done*  by  others. 

If  the  banker  is  found  wanting  in  any  of  these  re- 
spects, or  his  judgment  proves  to  be  faulty,  he  loses  the 
confidence  of  those  who  habitually  participate  in  syndi- 
cates, and  with  it,  his  capacity  to  engage  in  financial 
transactions  on  a  large  scale,  as  it  is  only  with  the  co- 
operation, financial  or  otherwise,  of  syndicates  that 
large  transactions  can  be  carried  through. 


The  Penalty  of 
Failure  on  the 
Banker's    Part 


The  spread  on  which  the  syndicate  figures  as  between 
the  purchase  price  and  the  price  of  resale  to  the  public 
is  not  more  than  suflScient  to  cover  the  expense  of  "over- 
head," the  outlay  for  advertising,  circularizing  and  coun- 
sel fees,  and  reasonable  compensation  divided  over  hun- 
dreds of  syndicate  participants  and  distributing  houses 
for  their  risk  and  their  work  in  placing  the  securities 
with  the  public.  In  view  of  the  change  which  has  taken 
place,  as  previously  referred  to,  in  the  clientele  for  rail- 
road bonds  (owing  to  the  preference  of  large  investors 
for  tax-exempt  bonds)  the  selling  of  railroad  securities 
has  become  both  a  more  laborious  and  intensive  and  a 
more  costly  process  than  formerly.  In  addition  to  a 
highly  trained  and  expensive  office  staff,  bondhouses 
nowadays  must  employ  an  army  of  travelling  salesmen. 

In  order  to  get  issues  of  railroad  securities  well  placed 
among,  and  absorbed  by,  bona  fide  investors,  it  is  neces- 
sary, under  the  conditions  created  by  the  advent  of  high 
surtaxes,  to  employ  retail  distributing  houses  through- 
out the  country  to  a  far  greater  extent  than  used  to  be 
the  case.  The  margin  upon  which  the  calculations  of 
the  syndicate  and  its  managers  are  based,  must  therefore 


Extensive 
Distributing 
Service  Must 
Be  Employed 


32 


Banker's  Profit 
Limited,  But 
His  Loss 
Indeterminate 


be  sufficient  to  enable  reasonable  compensation  to  be 
afforded  to  such  retail  distributing  houses  so  as  to  give 
them  a  fairly  adequate  inducement  to  put  forth  their 
efforts  in  placing  the  securities. 

If,  through  an  excessive  narrowing  of  the  margin, 
whether  due  to  vagaries  of  competitive  bidding  or  to 
other  causes,  such  adequate  inducement  cannot  be  given 
to  that  nation-wide  force  of  distributing  houses  in  the 
case  of  railroad  securities,  the  inevitable  result  would 
be  that  these  houses  would  more  and  more  relinquish 
that  field  and  devote  their  principal  attention  to  pushing 
the  distribution  of  industrial  and  other  securities,  of 
which  a  constantly  growing  supply  is  available. 

Under  the  methods  now  prevailing,  it  is  wholly  im- 
possible that  the  originating  banker,  the  syndicate  par- 
ticipants and  the  distributing  houses  can  make  an  vmdue 
profit  as  between  the  railroads  and  the  public.  The  ex- 
pected compensation  for  their  respective  services  is  ex- 
pressed in  practically  standardized  percentages,  varying 
somewhat  in  accordance  with  the  quality  of  the  security 
and  the  risk  and  difficulty  of  the  business.  There  can  he 
no  profit  to  bankers,  syndicates  or  distributors  over  and 
above  these  percentages,  but  of  course  there  can  he  a 
loss  if  the  banker's  judgment  as  to  the  price  which  a 
given  security  is  worth  or  as  to  the  general  condition  of 
the  investment  market  is  at  fault,  or  if  a  sudden  change 
occurs  in  that  market  owing  to  unforeseen  events.  The 
limit  of  possible  profit  is  fixed,  the  limit  of  possible  loss 
is  indeterminate. 


Service  of 
European  Bank- 
ers Less  Com- 
prehensive Than 
American 


It  is  worth  mentioning  in  this  connection  that  the 
banker  in  England  does  not  render  the  same  measure  of 
service  to  the  corporations  whose  securities  he  sells  to 


33 


the  public,  as  does  the  American  banker.  It  is  the  prac- 
tice of  the  London  banker,  immediately  after  the  public 
issue  has  taken  place,  to  dissolve  his  syndicate,  distribute 
amongst  the  syndicate  participants  any  bonds  remain- 
ing unsold  and  leave  it  to  them  to  sell  at  the  best  price 
they  can  get.  He  does  not  usually  consider  himself 
responsible  to  endeavor  to  protect  the  stability  of  the 
issue  price. 

The  practice  of  the  American  banker,  on  the  contrary, 
in  cases  where  a  public  issue  has  not  resulted  in  pla- 
cing with  the  public  the  entire  amount  offered,  is  to 
keep  his  syndicate  together  for  a  certain  length  of 
time  (sometimes  for  a  great  length  of  time),  to  re- 
tain charge  of  the  disposal  of  the  unsold  balance  and  to 
continue  his  efforts  to  place  the  same  with  the  investing 
public  at  the  original  issue  price — a  practice  fairer  and 
more  serviceable  both  to  the  railroads  and  to  the  public. 
Even  in  the  case  of  wholly  successful  issues,  it  is  the 
usual  practice  here  to  keep  the  syndicate  together  for 
from  two  to  three  months,  so  as  to  be  ready  to  "protect" 
the  market,  as  more  fully  explained  later. 


American 
Practice  More 
Serviceable  and 
Involves  Greater 
Responsibility 


Some  Instances  of  Syndicate  Risks  Turned 

Into  Losses 


The  following  actual  cases  which  are  by  no  means 
exhaustive,  indicate  the  risks  incurred  by  banking  syndi- 
cates, and  illustrate  the  losses  and  vicissitude  to  which 
they  are  subject: 

1.  In  September,  1905,  The  Erie  Railroad  ar- 
ranged with  its  bankers  to  form  a  sjmdicate  to 
underwrite  the  offer  to  its  shareholders  at  100%  of 
$12,000,000  Convertible  4%  Bonds,  Series  "B"  (con- 
vertible into  common  stock  at  $60  per  share).     The 


Erie 


34 


M.  K.  A  T. 


Union 
Pacific 


B.  &  O. 


Wisconsin 
Central 


result  of  the  offering  was  that  the  stockholders 
subscribed  for  only  18  per  cent  and,  consequently, 
the  syndicate  had  to  take  and  pay  for  $9,840,000  of 
the  bonds.  The  syndicate  was  dissolved  in  December, 
1906,  none  of  the  bonds  taken  by  it  having  been  dis- 
posed of.  The  bonds  were  listed  on  the  Stock 
Exchange  in  February,  1907,  when  they  sold  at  85%. 

2.  In  January,  1906,  The  Missouri,  Kansas  & 
Texas  Railway  arranged  with  its  bankers  to  form 
a  syndicate  to  underwrite  the  offer  to  its  shareholders 
at  871/2%  of  $10,000,000  General  Mortgage  41/2% 
Bonds.  The  stockholders  subscribed  for  only  50  per 
cent  of  the  offering  and  the  syndicate  had  to  take 
$5,000,000  of  the  bonds.  The  syndicate  was  dis- 
solved in  December,  1907,  only  a  few  of  the  bonds 
taken  by  it  having  been  disposed  of. 

3.  In  May,  1907,  the  Union  Pacific  arranged  with 
its  bankers  to  form  a  syndicate  to  underwrite  the 
offer  to  its  stockholders  at  90%  of  $75,000,000 
4%  Convertible  Bonds  (convertible  into  stock  at 
175%).  The  stockholders  subscribed  for  barely  5  per 
cent  of  the  offering  and,  consequently,  the  syndicate 
had  to  take  and  pay  for  about  $70,000,000  of  the 
bonds.  The  bonds  in  the  course  of  the  following  six 
months  declined  to  7814%' 

4.  In  January,  1913,  the  Baltimore  &  Ohio  Rail- 
road Company  arranged  with  its  bankers  to  form 
a  syndicate  to  underwrite  the  offer  to  its  stock- 
holders at  951/2%?  of  $63,000,000  41/2%  Convertible 
Bonds  (convertible  at  110%).  The  stockholders  sub- 
scribed for  barely  30  per  cent  of  the  offering  and, 
consequently,  the  syndicate  had  to  take  and  pay  for 
about  $44,000,000  of  the  bonds.  In  the  course  of 
a  few  months  the  bonds  declined  to  88^2%- 

5.  In  April,  1906,  the  Wisconsin  Central  Railway 
arranged  with  bankers  to  form  a  syndicate  to  under- 
write   the    offer    to    its    shareholders    at    89%    and 


35 


interest,  of  $7,000,000  Superior  &  Duluth  Division  & 
Terminal  First  Mortgage  4%  Bonds.  The  stock- 
holders subscribed  for  only  1  per  cent  of  the  of- 
fering and  the  syndicate  had  to  take  $6,930,000  of 
the  bonds.  The  syndicate  expired  by  limitation 
July  1,  1908,  none  of  the  bonds  taken  by  it  having 
been  disposed  of  in  the  interval. 

6.  In  March,  1910,  The  Atchison,  Topeka  &  Santa 
Fe  Railway  Company  arranged  with  its  bankers  to 
form  a  syndicate  to  underwrite  the  offer  to  its  share- 
holders at  1021/2%  of  $43,686,000  Convertible  4% 
Bonds  due  1960.  The  stockholders  subscribed  for 
only  about  12^2  per  cent  of  the  offering,  leaving 
about  $38,000,000  of  the  bonds  to  be  taken  by  the 
syndicate. 

7.  In  February,  1906,  the  Southern  Railway  sold 
to  its  bankers  $20,000,000  Development  and  General 
Mortgage  4%  Bonds  at  89%  less  commission.  The 
syndicate  formed  by  the  bankers  to  handle  this 
transaction  remained  in  existence  for  nearly  21^ 
years,  i.  e.,  till  July  1,  1908,  at  which  time  the  syndi- 
cate members  had  to  take  up  68  per  cent  of  their  par- 
ticipations. The  market  price  of  the  bonds  at  that 
date  was  74%. 

8.  In  January,  1909,  the  Western  Maryland  Rail- 
road sold  to  bankers  $6,500,000  First  Mortgage  4% 
Bonds.  On  January  18,  1909,  about  90  per  cent  of 
the  bonds  had  to  be  taken  up  by  syndicate  partici- 
pants. No  bonds  were  disposed  of  by  the  syndicate 
until  September,  1910,  and  from  then  on,  at  various 
dates  up  to  February  28,  1911 ;  thus  the  syndicate 
lasted  more  than  two  years. 

9.  In  June,  1909,  the  Seaboard  Air  Line  arranged 
with  bankers  for  the  formation  of  a  syndicate  to 
guarantee  the  sale  of  $18,000,000  Adjustment  Bonds 
at  70%.  November  1,  1909,  syndicate  members  took 
up  about  90  per  cent  of  the  bonds,  which  were  dis- 


Sante  Fe 


Southern 


Western 
Maryland 


Seaboard 
Airline 


36 


Chicago  City  and 

Connecting 

Railway 


posed  of  in  small  lots  between  February,  1910,  and 
November  30,  1910,  the  syndicate  thus  lasting  about 
one  and  one-half  years. 

10.  In  January,  1910,  bankers  purchased  $22,- 
000,000  Chicago  City  &  Connecting  Railways  Col- 
lateral Trust  5%  Bonds,  and  formed  a  syndicate  at 
91%.  The  syndicate  expired  in  February,  1912, 
leaving  syndicate  members  with  almost  90  per  cent 
of  the  total  amount  unsold  in  their  hands. 


Examples  Prom 
War  and  Post- 
War  Periods 


C.  &  O. 


C.  M.  &  St.  P. 


It  will  be  observed  that  all  the  above  examples,  the  list 
of  which  could  be  considerably  prolonged,  relate  to  the 
period  preceding  the  war.  The  selection  has  been  so 
made  purposely,  because  ever  since  the  beginning  of  the 
war  the  conditions  of  the  investment  market  have  not 
been  normal.  During  the  greater  part  of  that  period 
they  were  abnormally  adverse,  while  since  the  beginning 
of  the  present  year  they  have  been  abnormally  favor- 
able. Therefore,  the  war  and  post-war  periods  offer 
no  basis  upon  which  to  found  permanent  conclusions. 
However,  a  few  examples  from  these  periods,  which 
might  be  greatly  multiplied,  may  be  inserted  here: 

11.  In  March,  1916,  bankers  formed  a  s^mdicate 
to  underwrite  the  offer  to  stockholders  of  .$40,180,- 
000  Chesapeake  &  Ohio  Railway  Co.  30  year  5% 
Secured  Convertible  Gold  Bonds  at  97l^%  and  ac- 
crued interest.  The  stockholders  subscribed  for  but 
slightly  over  5  per  cent  of  the  offering  and  the 
syndicate  had  to  take  and  pay  for  $38,047,500  of 
the  bonds,  equal  to  94%  per  cent  of  the  issue.  At 
the  time  when  the  syndicate  was  called  upon  to  make 
good  its  obligation,  the  bonds  were  selling  in  market 
at  94%%. 

12.  In  January,  1917,  the  Chicago,  Milwaukee  and 
St.  Paul  Railway  sold  to  its  bankers  at  931/2%  $25,- 


3T 


000,000  General  and  Refunding  Mortgage  41/4% 
Bonds,  Series  "A",  due  January  2014,  On  April  24, 
the  syndicate  was  dissolved,  the  members  having  to 
take  up  43  per  cent  of  their  participations.  The 
bonds  at  that  time  were  selling  in  the  market 
at  881/2%. 

13.  In  June,  1919,  the  Baltimore  &  Ohio  Railroad  B.  &  O. 
Company   sold   to    its   bankers   at   931/2%   $35,000,- 

000  of  Ten-Year  6%  Secured  Gold  Bonds.  The 
syndicate  remained  in  force  until  January  30,  1920, 
when  the  members  had  to  take  up  23  per  cent  of  their 
participations.  The  bonds  were  then  selling  in  the 
market   at   83%%. 

14.  In     July,     1919,     the     Cleveland,    Cincinnati,  C  C.  C.  &  St.  L. 

Chicago  &  St.  Louis  R.  R.  Co.  sold  to  its  bankers 
at  951/2%  $15,000,000  6%  Bonds.  On  December  1, 
1919,  the  syndicate  was  dissolved,  the  members  having 
to  take  up  11  per  cent  of  their  participations.  The 
bonds  were  then  selling  in  the  market  at  about  86%. 


38 


Certainty  of 
Securing  Funds 
Maintains  Rail- 
road Credit 


VIII 

The  Nature  and  Value  of  an  Estab- 
lished Banking  Relationship 

The  considerations  which  make  a  system  under  which 
railroads  would  offer  their  securities  direct  for  public 
bidding,  precarious,  hazardous  and  futile  are  so  patent 
and  so  conclusive,  that  it  mav  well  be  assumed  that  no 
reasonably  informed  person  will  contend  seriously  that 
it  would  be  either  advantageous  or  safe  for  railroad 
companies  to  pursue  the  course  of  attempting  to  market 
their  securities  without  the  trained  cooperation  of 
bankers. 

The  question  remains  to  be  discussed  whether  it  is  in 
the  public  interest  that  a  railroad  company  should  habit- 
ually deal  with  a  particular  banker  and  give  that  banker 
the  preference  when  it  has  securities  to  be  sold  or  under- 
written as  long  as — and  only  so  long  as — it  is  satisfied 
with  his  services.  The  following  considerations  are 
offered  in  support  of  this,  the  existing  practice : 

1.  The  present  plan  enables  a  railroad  to  be  certain 
of  its  ability  to  secure  the  necessary  funds  for  its  com- 
mitments. 

It  is  of  the  greatest  importance  for  a  railroad,  when 
making  commitments  for  expenditures  for  improve- 
ments, new  construction,  equipment,  etc.,  to  be  certain 
that  it  will  be  able  to  sell  the  requisite  securities  when 
such  commitments  come  due  and  must  be  met.  That  is 
a  fundamental  principle  of  sound  raili'oad  financing. 

In  dealing  regularly  with  a  banking  house  of  ample 
financial  strength  and  wide  connections,  the  railroad 
company  is  assured  that  it  will  be  able  to  obtain  the 
requisite  funds,  even  in  unfavorable  times,  because  the 


39 


banking  house,  in  order  to  insure  the  continuity  of  the 
connection  and  the  solvency  of  the  railroad,  cannot  do 
otherwise  than  use  to  the  utmost  the  resources  and  the 
facilities  of  connections  and  credits  at  its  disposal,  to 
provide  for  the  requirements  of  the  railroad. 

If,  on  the  other  hand,  the  railroad  had  been  in  the 
habit  of  selling  its  securities  on  a  competitive  basis,  it 
would  have  no  such  friend  in  need,  and  the  various  bond 
and  banking  houses  would  naturally  buy  its  securities 
only  as  it  suited  their  own  purposes.  The  strongest 
railroads  have  found  themselves  in  the  situation  where 
large  sums  of  money  have  been  imperatively  needed  in 
most  unfavorable  times  and  where  only  their  claims 
upon  their  regular  bankers  have  enabled  them  to  obtain 
the  necessary  funds. 

It  has  of  late  years  been  a  matter  of  not  infrequent 
occurrence  that  during  the  pendency  of  applications 
for  the  approval  by  a  public  service  commission  of  pro- 
posed bond  issues,  railroads  have  found  themselves  in 
need  of  temporary  financial  accommodation.  For  such 
accommodation,  if  not  readily  or  opportunely  obtain- 
able from  the  railroad's  banks  and  trust  company  con- 
nections, the  railroad  would  turn  to  its  banker. 

Furthermore,  in  the  case  of  bonds,  the  appHcation  for 
the  issue  of  which  is  pending  before  a  pubhc  service 
commission,  it  is  not  unusual  for  the  banker,  at  the 
railroad's  request,  to  obligate  himself  to  purchase  such 
bonds,  subject  to  the  ap]3roval  of  their  issue  by  such 
commission,  so  that  the  railroad  is  protected  against  an 
unfavorable  change  in  the  investment  markets  while  its 
application  is  being  considered  and  is  certain  of  obtain- 
ing the  needed  funds  as  soon  as  the  application  is 
granted. 


Temporary 
Accommoda- 
tions Often 
Required 
By  Railroads 


40 


Assistance  of 
Banking  House 
May  Mean 
Avoidance  of 
Bankruptcy 


The  temporary  financial  accommodation  previously 
referred  to,  and  the  definite  sale  of  bonds  in  advance  of, 
and  subject  to  action  by  public  service  commissions, 
have  at  times  been  of  great  service  and  value  to  rail- 
roads. It  is  doubtful  whether  either  expedient  would 
be  at  the  service  of  a  railroad  if  securities  were  sold  by 
competitive  bidding  among  bankers. 


There  have  also  been  numerous  instances  when  rail- 
roads which  found  themselves  confronted  with  grave 
financial  problems  or  in  need  of  large  sums  for  refund- 
ing purposes  have  applied  to  bankers  to  evolve  plans 
and  inaugurate  measures  for  dealing  with  these  prob- 
lems comprehensiveh^  for  strengthening  their  credit,  or 
for  their  financial  rehabilitation  without  the  expense  and 
detriment  of  a  receivership.  The  accomplishment  of 
this  task  on  the  part  of  the  banker  involves  much  time, 
thought  and  study  as  well  as  a  degree  of  financial  risk 
and  the  assumption  of  great  moral  responsibility  toward 
investors  who,  following  the  banker's  advice,  may  aid 
in  furnishing  the  requisite  funds  and  who  look  to  the 
banker  to  safeguard  such  investments. 

Last  April,  for  example,  the  New  York,  Xew  Haven 
&  Hartford  Railroad  Company  was  faced  with  the 
maturity  of  $28,000,000  of  debentures  of  which  one-half 
were  held  in  France  and  one-half  in  this  country.  The 
company's  credit  was  not  suflficient  to  make  a  new  issue 
of  securities  possible.  Failure  to  meet  or  extend  the 
debentures  at  maturity  would  have  meant  bankruptc^^ 

With  the  active  aid  of  banking  houses  through  whom 
the  debentures  had  been  placed  originally  and  with 
whom  the  company  had  been  in  consultation  many 
months  in  advance,  a  voluntary  extension  of  the  deben- 


41 


tures  was  secured.  The  negotiations  involved  a  great 
deal  of  time,  thought,  skill  and  effort,  and,  it  is  fair 
to  say,  could  not  have  been  successfully  concluded,  ex- 
cept through  the  influence,  prestige,  sidll  and  activity 
of  the  banking  houses  concerned. 

It  is  a  significant  fact  that  most  of  the  railroads  which 
have  gone  into  receivers'  hands  in  recent  years  had  fol- 
lowed the  practice  of  selling  their  securities  to  different 
bankers  at  different  times,  and  for  the  financing  and 
support  of,  and  advice  to,  such  railroads,  and  the  preser- 
vation of  their  solvency,  accordingly,  no  single  banking 
house  felt  itself  responsible.* 


2.  A  railroad's  financial  requirements  must  be  fore- 
seen aaid  assured  long  in  advance  of  the  actual  need,  and 
the  present  practice  makes  that  possible. 

In  July,  1921,  when  investment  conditions  had  not 
yet  become  propitious  an  issue  of  the  combined  bonds 
of  the  Northern  Pacific  and  Great  Northern  Companies 
aggregating  $200,000,000  fell  due.  The  refunding  of 
this  vast  amount  of  bonds  was  successfully  accomplished 
with  the  aid  of  the  bankers  who  had  been  concerned  in 
their  issue  originally.  The  preparations  for  this  re- 
funding operation  had  been  in  progress  for  the  best 
part  of  a  year  and  were  necessarily  of  the  most  elabo- 
rate character. 

Manifestly,  this  immense  operation  could  have  been 
successfully  carried  through  on  an  acceptable  basis  only 
by  experienced  bankers  of  high  standing  and  nation- 
wide connections,  who  were  familiar  with  the  history  of 

*  (Examples:  Wabash,  Western  Maryland,  Wheeling  &  Lake  Erie, 
Kansas  City,  Mexico  &  Orient,  St.  Louis  &  San  Francisco,  Norfolk  & 
Southern,  Chicago  Great  Western,  Chicago  Rock  Island  &  Pacific, 
etc.) 


Preparation 
Required  for 
$200,000,000 
N.  P.-G.  N. 
Refunding 


42 


Cases  of  Security 
Sales  Requiring 
Protracted  and 
Complex 
Xegotiations 


the  transaction  and  the  manner  in  which  the  securities 
to  be  refunded  were  held,  and  who  had  adequate  induce- 
ment to  give  to  this  complex  and  difficult  negotiation 
the  time  and  thought  and  the  painstaking  effort  which 
its  preparation  required. 

In  June,  1906,  when  the  investment  market  in  this 
country  was  practically  at  a  standstill,  American  bank- 
ers placed  an  issue  of  Francs  250,000,000  Pennsylvania 
ComiDany  3%%  Bonds  in  France;  in  February,  1907, 
an  issue  of  Francs  145,000,000  New  York,  New  Haven 
&  Hartford  Railroad  Company  4%  Bonds  in  France 
and  Germany;  in  March,  1910,  an  issue  of  Francs  150,- 
000,000  Chicago,  Milwaukee  &  St.  Paul  4^%  Bonds  in 
France  and  England;  and  in  February,  1911,  an  issue 
of  Francs  250,000,000  Central  Pacific  Railway  Com- 
pany 4%  Bonds  in  France  and  England. 

All  of  these  loans  were  negotiated  at  times  when  it 
was  of  great  advantage  to  the  railroads  as  well  as  to  the 
general  financial  situation  to  obtain  money  abroad. 
They  took  many  weeks  of  preliminary  negotiation  and 
complex  arrangements  and  could  not  possibly  have  been 
negotiated  on  a  competitive  basis. 

One  railroad  company  alone  must  provide  for  $130,- 
000,000  of  maturities  in  1925 — and  another  for  $50,- 
000,000  the  same  year.  It  will  inevitably  be  necessarj'^ 
for  these  companies  to  consult  with  bankers  a  long  time 
before  the  maturity  date,  and  devise  plans  for  refund- 
ing, and  obtain  competent  advice  as  to  the  best  moment 
and  method  for  carrying  out  these  large  transactions. 

No  banker  could  reasonably  be  expected  to  under- 
take the  task  and  assume  the  responsibility  of  building 
up  a  railroad's  credit,  of  studying  and  advising  upon 
financial  policies  and  methods,  and  putting  his  skill  and 
placing  power  and  sponsorship  at  its  disposal  if  he  had 


43 


to  expect  that  after  having  devoted  his  time,  effort  and 
reputation  to  the  work,  the  security-issues  of  the  rail- 
road tvould  he  thrown  open  to  competitive  bidding, 
whether  general  or  confined  to  hankers,  regardless  of 
whether  or  not  his  own  services  were  faithful  and  efficient 
and  satisfactory  to  the  hoard  of  directors  and  manage- 
ment. 


3.  The  technical  advice  and  the  assistance  growing 
out  of  the  practical  experience  of  the  banker  are  of  great 
value  to  the  railroad. 

A.     Importance  of  Advice  as  to  the  Best  Time  to 

Issue  Securities 

In  dealing  regularly  with  one  banking  house,  a  rail- 
road obtains  the  benefit  of  expert  advice  (and  that  from 
some  one  thoroughly  familiar  with,  and  interested  in, 
its  affairs)  as  to  financial  policy,  as  to  the  best  and  most 
opportune  time  for  selling  securities,  and  for  providing 
for  its  financial  requirements,  as  to  the  class  and  kind  of 
securities  best  suited  to  conditions  prevailing  and  to 
be  anticipated,  and  as  to  the  best  method  of  offering 
them  to  the  public. 

The  element  of  the  selection  of  time  is  of  much  impor- 
tance in  itself,  for  it  happens  not  infrequently  that  the 
lapse  of  a  single  week  or  less  measures  the  difference 
between  reasonably  favorable  and  unfavorable  or  even 
totally  forbidding  conditions. 

The  ebb  and  flow  of  the  currents  in  the  investment 
markets  depend  on  many  and  complex  conditions  and 
considerations,  and  it  is  one  of  the  functions  of  the  com- 
petent banker  to  keep  himself  posted  as  to  affairs,  as- 
pects and  prospects  in  America,  Europe,  and  elsewhere. 


Competitive 
Bidding  Would 
Deprive  Railroad 
of  Financial 
Advice  of  Bank- 
ing Houses 


Time  Element 
Important  to 
Railroads 


4i 


Advice  and 
Cooperation  In 
Declining 
Markets 


Pi*ospective 
Bidders  Would 
Benefit  By 
Decline 


and  to  anticipate  in  his  judgment  and  advice  their  re- 
sults and  their  effects  upon  the  money  and  investment 
markets. 

The  advice  and  co-operation  of  the  banker  are  espe- 
cially important  to  railroad  companies  during  periods  of 
declining  security  values,  with  which  the  Interstate  Com- 
merce Commission  has  not  yet  had  occasion  to  deal,  inas- 
much as  during  the  more  recent  past  there  has  been  an 
almost  continuous  upward  trend  of  prices.  In  times  of 
declining  markets  for  securities,  quick  action  and  sound 
advice  are  particularly  essential.  Premature  publica- 
tion of  a  company's  intention  to  issue  new  securities 
must  be  guarded  against.  Apart  from  other  considera- 
tions, holders  of  its  securities  already  outstanding  might 
hasten  to  sell  their  holdings  without  waiting  for  full  in- 
formation. Such  premature  selling  might  so  affect  the 
market  as  to  make  the  new  transaction  more  costly  or 
perhaps  impossible. 

Furthermore,  public  knowledge  that  one  or  more  is- 
sues of  railroad  securities  are  contemplated,  might  cause 
industrial  concerns  or  foreign  governments  or  munici- 
palities to  hasten  offerings  of  their  own  securities,  as 
indeed  has  occurred  in  the  past,  so  as  to  anticipate  the 
railroads'  offerings  and  get  prior  access  to  the  invest- 
ment market.  The  supply  of  available  investment  capi- 
tal has,  of  course,  its  limitations,  and  in  normal  times  the 
rule  "first  come,  first  served"  does  apply  to  a  certain 
degree. 

If  a  sale  by  public  tender  or  by  competitive  negotiat- 
ing or  bidding  among  bankers  were  required,  no  one 
would  be  interested  in  supporting  the  market  for  a 
company's  outstanding  securities;  in  fact,  prospective 
bidders  would  be  benefited  by  a  decline.     On  the  other 


45 


hand,  with  bankers  having  a  continued  interest  in  its 
welfare  and  a  publicly  recognized  moral  responsibility 
for  its  securities,  the  situation  is  quite  different. 


In  this  connection  the  question  may  be  pertinent  as 
to  the  relative  desirability  of  the  practice  of  selling 
securities  before  (or  simultaneously  with)  the  applica- 
tion to  the  Interstate  Commerce  Commission  for  ap- 
proval, the  transaction  being  made  subject  to  the  Com- 
mission's subsequent  a])proval,  or  of  delaying  the 
offering  until  the  Commission's  approval  has  actually 
been  obtained.  On  the  whole,  the  first  method,  although 
not  free  from  objection,  would  seem  to  be  the  safer  and 
more  desirable  from  the  point  of  view  of  the  railroads. 
It  is  quite  impossible  for  any  banker  to  definitely  advise 
a  corporation,  with  any  degree  of  positiveness,  as  to  the 
price  its  securities  will  command  several  weeks  later. 
Too  many  elements  of  uncertainty  are  involved.  The 
publication,  weeks  in  advance  of  the  actual  consumma- 
tion of  the  transaction,  of  the  intention  of  railroad  com- 
panies to  make  issues  of  securities  might  prove  seriously 
detrimental  as  indicated  in  the  preceding  paragraph. 

Everything  considered,  it  would  seem  best  that  the 
companies  should  be  accorded  discretion  to  exercise  their 
own  best  judgment  in  each  instance  whether  they  should 
sell  subject  to  subsequent  approval  by  the  Commission, 
or  should  first  obtain  the  Commission's  leave  for  selling, 
at  a  price  not  below  a  stated  minimum. 


B.     Importance  of  Advice  as  to  Technical  Details 
Surrounding  Issuance  of  Securities 

It  is  of  great  importance  that  care  should  be  taken 
that  new  issues  of  bonds  should  comply  with  the  statu- 


Itnportaiice  of 
AUowing  Exer- 
cise of  Maximimi 
Discretion  By  the 
Oompanies 


46 


Investors  Look 
To  Bankers  to 
Safe^ard  Securi- 
ties Technically 


tory  requirements  of  various  states  respecting  legal  in- 
vestments of  insurance  companies,  savings  banks  and 
other  fiduciary  institutions.  Whether  or  not  a  given 
issue  of  bonds  meets  these  requirements  will  often  make 
a  difference  of  several  points  in  their  value. 

Investors  attach  considerable  importance  to  knowing 
that  the  mortgages,  trust  deeds,  etc.,  and  all  legal  steps 
relating  to  the  issue  of  securities  which  they  are  asked  to 
buy  have  been  carefully  examined  by  bankers  of  repute 
and  experience  and  their  counsel,  with  a  view  to  safe- 
guarding the  interest  of  the  holders  of  the  bonds  as  dis- 
tinguished from  those  of  the  railroads,  the  makers  of 
the  bonds. 

The  mortgages  and  trust  deeds  under  which  the  se- 
curities are  to  be  issued,  before  being  put  in  final  shape, 
are  carefully  gone  over  by  the  banker,  and  his  advice 
is  given  with  the  view  to  creating  the  best  and  most 
saleable  instrument  satisfactory  both  to  the  public  and 
to  the  railroad  company,  and  having  due  regard  both 
for  the  protection  of  the  investor  and  for  the  future 
financial  requirements  of  the  railroad.  Such  advice  is 
frequently,  especially  in  the  case  of  large  refunding 
mortgages  which  are  meant  to  be  the  principal  means 
of  raising  money  for  the  railroads  for  years  to  come,  of 
very  great  utility.  It  is  likewise  greatly  valued  by  the 
investor  who  has  come  to  rely  upon  the  tried  and  tested 
thoroughness  and  competence  of  experienced  and  highly 
reputed  tankers  to  protect  the  interests  of  the  investing 
pubhc  in  respect  of  not  only  the  intrinsic  goodness  of 
a  security  for  which  they  become  sponsors,  but  also  in 
respect  of  the  provision  of  the  mortgage  or  trust  deed 
appertaining  to  such  security. 


47 


4.  The  bankers'  dual  obligation  to  the  investing  pub- 
lic on  the  one  hand  and  on  the  other  to  the  corporations 
whom  he  serves,  constitutes  a  protection  to  both. 

The  leading  bankers  could  not  maintain  their  position 
as  such,  if  they  did  not  have  the  confidence  of  the  invest- 
ing public  and  a  large  following  amongst  investors, 
large  and  small,  both  here  and  abroad. 

Careful  analysis,  continuous  and  watchful  scrutiny, 
in  respect  of  securities  issued  by  him  and  of  the  com- 
panies concerned,  are  essential  functions  of  the  banker. 
In  buying  securities  and  offering  them  for  sale,  he  gives 
public  notice,  so  to  speak,  that  he  has  examined  into,  and 
satisfied  himself  as  to,  their  safety  and  merit. 

The  banker  does  not  safeguard  merely  the  technical 
and,  to  the  best  of  his  ability,  the  intrinsic  soundness  of 
the  securities  he  issues;  it  is  alike  his  duty  and  to  his 
own  self-interest  to  protect  and  stand  behind  the  securi- 
ties for  which  he  is  recognized  as  sponsor,  just  as  it  is 
his  duty  and  to  his  own  self-interest  to  satisfy  himself 
by  careful  investigation  as  to  the  soundness  of  such  se- 
curities, because  the  banker  whose  clients  suffer  loss 
through  following  his  advice  will  very  soon  lose  his 
reputation  and  the  confidence  and  patronage  of  his 
clients. 

The  banker  knows  well  that  such  reputation  and  con- 
fidence are  the  mainstays  of  the  prosperity  and  success 
of  his  own  business  and,  once  forfeited,  are  exceedingly 
difficult  to  regain. 


"Protecting^'  the  Market 

The  function  of  the  hanker  in  "protecting"  the  market 
for  securities  issued  through  his  hou^e  is  of  peculiar 
importance. 


Investors  Rely  on 
Integiity  and 
Judgment  of 
Bankers 


48 


Important  That 
Small  Investors 
Be  Protected 


Ready  Market 
Must  Be  Secured 
For  Re>8ales 


Reference  has  been  made  to  the  altered  character  of 
the  investment  market,  in  which  a  great  army  of  small 
investors  has  come  into  existence  to  take  the  place  of 
the  larger  investors  who  because  of  preference  for  tax- 
exempt  securities,  can  no  longer  be  counted  upon  to  be 
a  considerable  factor  in  absorbing  railroad  securities. 

If  that  army,  so  important  and  desirable  from  the 
social  and  economic  viewpoint,  and  created  at  such  great 
cost  and  effort,  is  not  to  disintegrate  again,  it  is  abso- 
lutely indispensable  that  the  market  for  the  securities 
which  they  have  bought,  be  "protected"  at  least  for  a 
reasonable  length  of  time  after  the  offering  (barring 
exceptional  economic  or  financial  changes) — ^which  pro- 
tection is  one  of  the  useful  and  legitimate  functions  of 
leading  issuing  houses  and  has  no  relationship  whatever 
to  what  is  usually  termed  manipulating  or  "rigging" 
the  market. 

It  must  he  made  somebody's  business  to  see  to  it  that 
if  the  investor  wishes  to  sell  within  a  reasonable  time 
after  having  bought,  he  can,  under  normal  conditions, 
find  a  market  at  or  near  the  price  at  which  he  bought. 

To  provide  such  a  market  by  being  able  and  willing 
to  a  reasonable  extent  to  repurchase  bonds  sold  by  him, 
is  part  of  the  business  of  the  banker  who  made  the  pub- 
lic offering — provided  that  he  has  a  definite  and  ac- 
knowledged relationship  toward  the  company  whose 
bonds  he  has  offered.  If  he  has  no  such  relationship,  if 
the  public  offering  is  simply  the  result  of  competitive 
bidding,  either  general  or  hmited,  the  banker  may  be 
expected  to  be  apt  to  feel  that  his  functions  are  com- 
pleted when  he  has  marketed  the  securities. 


49 


The  result  would  be  that  the  immensel}''  valuable  work 
which  had  been  done  lately  of  popularizing  railroad 
bonds  might  be  largely  undone,  the  vast  clientele  which 
had  been  created  for  railroad  bonds  might  be  materially 
curtailed,  and  the  resulting  diminished  demand  for  rail- 
road bonds  could  not  fail  to  be  reflected  in  the  price  level 
which  they  would  command. 


The  continuing  responsibility  of  the  banker  for  bonds 
which  he  has  offered  and  sold  under  the  existing  system 
of  deahng  between  bankers  and  railroads  is  an  exceed- 
ingly valuable  element  from  the  point  of  view  of  the 
small  investor  and  a  strongly  steadying  factor  in  the 
market  for  railroad  securities.  That  responsibility 
would  be  jeopardized  by  competitive  bidding,  whether 
general  or  limited. 

It  is  interesting  to  note  in  this  connection  that  even  so 
eminently  successful  a  public  offering  as  that  of  the 
recently  issued  United  States  Government  41/4%  Bonds, 
was  followed  by  a  substantial  decline  in  the  market  price 
of  those  bonds  below  the  price  of  issue.  There  being 
no  one  responsible  for  the  "protection"  of  the  market 
for  those  bonds,  the  price  declined  quickly  from  the 
issuing  price  of  100  to  98.90%,  which  in  the  case  of  the 
world's  premier  government  security  has  considerably 
greater  significance  than  a  like  decline  would  have  in 
the  case  of  a  corporate  issue. 


Value  of  Banker's 

Continuing 

Responsibility- 


It  is  to  the  interest  of  a  railroad  company  that  its  se-    important 
curities  should  be  absorbed  by  the  investing  public  and    Disappointing 
that  their  market  value  should  he  maintained,  under    investors 
normal  conditions.    It  is  more  important  to  the  railroad 
industry  at  large  that  a  favorable  reputation,  the  good- 


50 


Issues  Sponsored 
By  Well  Known 
Bankers 

Have  Wider  and 
Steadier  Market 


will  of  the  investing  public  and  a  broad,  steady  demand 
for  its  securities  should  be  preserved  than  that  in  every 
instance  the  very  top  notch  price  should  be  obtained 
to  which,  through  taking  advantage  of  fortuitous  cir- 
cumstances, the  purchasing  banker  may  be  driven.  To 
disappoint  and  disgruntle  the  investor  by  selling  him 
securities  at  unduly  high  prices  which  will  not  stand  the 
test  of  the  workings  of  ordinary  supply  and  demand,  is, 
in  its  ultimate  consequences,  to  be  "penny  wise  and 
pound  foolish,"  especially  since  railroad  securities  are 
more  and  more  coming  into  competition  for  public  favor 
^vith  industrial  securities. 

The  end  the  railroad  companj"  should  alwa3's  have  in 
mind  is  to  maintain  a  broad  and  stable  market  for  its 
securities,  and  to  that  end,  wise  discretion  in  the  interest 
of  railroad  credit  generally  and  of  the  particular  bor- 
rower, may  even  make  it  desirable,  in  given  instances, 
under  all  the  surrounding  circumstances  of  the  case,  to 
accept  an  offer  which  would  enable  re-sale  to  the  public 
under  tested  and  responsible  auspices  at  a  fair  and  rea- 
sonable price,  rather  than  an  offer  of  an  extreme  price 
with  the  resulting  consequence  of  the  re-sale  to  the  pub- 
lic being  attempted  necessarily  at  an  unduly  high  level. 

It  may  safely  be  said  that  such  railroad  issues  as  are 
known  to  be  under  the  habitual  sponsorship  and  conse- 
quent moral  responsibility  of  well-known  and  strong 
bankers  have  a  wider  and  steadier  market  and  command 
better  prices  amongst  investors  than  those  which  are  not 
under  such  auspices  and  responsibility. 


If  the  sale  of  securities  were  thrown  open  to  competi- 
tive negotiating  or  bidding,  either  general  or  limited, 
the  possession  of  large  capital  would  tend  to  become 


51 


the  prime  requisite  for  dealing  in  securities,  and  the 
financier  or  combination  of  financiers  controlling  the 
largest  amount  of  capital  would  have  a  much  more 
potent  advantage  over  others  than  under  now  existing 
conditions. 

The  exercise  of  care,  skill,  industry,  scrutiny  and  the 
sense  of  rnoral  responsihility  toward  clients,  which  now 
are  and  always  have  been  the  prerequisite  for  acquiring 
the  reputation  and  the  public  confidence  upon  which  an 
Investment  Banker  s  jwsition  depends  and  without 
which  it  cannot  be  maintained  for  any  length  of  time, 
would  no  longer  be  essential. 


62 


IX 

Summary  and  Conclusion 

A.  The  vital  necessity  is  to  obtain  for  the  raih'oads 
the  assurance  of  adequate  capital  upon  favorable  terms. 

B.  The  existing  practice  of  selecting,  and  dealing 
with,  a  particular  banking  house  as  long  as  its  services 
give  satisfaction,  is  an  outgrowth  of  actual  experience 
in  the  effective  marketing  of  securities. 

C.  In  dealing  with  so  delicate  a  matter  as  security 
markets  it  is  of  primary  consequence  that  any  plan 
adopted  for  the  sale  of  securities  shall  command  the  ut- 
most confidence  on  the  part  of  investors. 

D.  The  existing  practice  has  proven  itself,  in  nmner- 
ous  instances,  of  the  greatest  utility  to  railroad 
corporations,  and  actual  experience  demonstrates  that 
the  remuneration  to  bankers  and  syndicates  is  but  a  fair 
equivalent  for  very  real  services  actually  performed  and 
risks  assumed,  and  that  the  average  of  such  remunera- 
tion, over  a  term  of  j^ears,  has  afforded  no  more  than 
a  reasonable  return  upon  the  capital  involved,  and  due 
compensation  for  the  w^ork  rendered. 

E.  The  existing  practice  has  been  found  effective  by 
industrial  corporations  not  subject  to  public  regulation, 
and  it  is  the  method  employed  by  many  foreign  govern- 
ments and  municij^alities  in  the  issuing  of  securities. 

F.  Some  of  the  adv^antageous  characteristics  of  the 
present  practice  are: 

1.  The  relationship  between   railroad  and  banker 
is  wholly  informal  and  continues  only  as  long  as  it 


>"3 


is  deemed  advantageous   to  the   railroad  bj  its  offi- 
cers and  directors. 

2.  The  relationship,  while  in  no  way  limiting  the 
railroad's  freedom  of  action,  does  impose  upon  the 
banker  definite  and  continuous  duties  and  obligations. 

3.  The  bankers  have  no  power  to  determine  the 
decision  of  railroads  in  such  matters. 

4.  The  banker  is  not  only  the  distributor  of,  and 
propagandist  for  railroad  securities,  but  he  fulfills, 
at  his  own  risk  and  cost,  the  important  and  valuable 
function  of  steadying  and  protecting  the  market 
for  such  securities. 

5.  The  railroad  receives  continuously  the  knowl- 
edge, services,  skill,  standing,  financial  advice,  and 
financial  potenc}'  of  the  banker  in  both  good  and  evil 
times. 

6.  The  banker  advises  as  to  the  financial  situation 
and  policy  of  the  railroad,  prepares  plans  for  meet- 
ing requirements,  recommends  the  kind  and  character 
of  the  security  to  be  created,  scrutinizes  mortgages 
and  trust  deeds,  and  indicates  the  best  moment  at 
which  to  sell. 

7.  The  bonds  of  the  corporation  represent  a  prom- 
ise to  pay.  The  value  of  that  promise  depends  not 
merely  upon  the  tangible  security  offered,  but  also 
upon  excellence  and  fidelity  of  management.  While 
strictly  refraining  from  any  attempt  to  influence  the 
operating  and  tariff  policies  of  the  railroad,  it  is 
the  banker's  duty  and  self-interest,  to  the  best  of  his 
ability,  to  promote  wise  and  sound  management  and 
safe  financial  policies  on  the  part  of  the  corporation, 
the  securities  of  which  he  has  issued  and  for  which  he 
has  consequently  assumed  moral  sponsorship  before 
the  investing  public. 

8.  Even  where  affiliations  between  particular 
bankers    and    railroads    avoid    nominal    competition, 


64 


there    is    a    potential    competition    which    operates 
powerfully  in  the  following  particulars: 

a.  The  fact  that  complete  publicity  is  by  law  en- 
forced as  to  the  terms  upon  which  security 
issues  are  obtained  by  bankers  naturally  causes 
both  the  banker  and  the  railroad  to  seek  to  give, 
on  the  one  hand,  and  to  obtain  on  the  other, 
the  best  terms  which  conditions  and  circum- 
stances warrant. 

b.  The  fact  that  the  terms  involved  in  a  contract 
between  the  railroad  and  the  banker  must  be 
approved  by  public  authority  is  a  moral 
guarantee  that  such  terms  will  be  proposed  as 
will  stand  well-informed  scrutiny. 

c.  If  railroads  find  that  other  companies  are  secur- 
ing better  terms  through  other  bankers,  it  is 
inevitable  that  other  bankers  will  ultimately 
obtain  the  business. 

d.  If  railroads  cannot  obtain  what  they  consider 
satisfactory  terms  from  their  regular  bankers, 
they  are  entirely  free  to  terminate  the  negoti- 
ations and  do  business  with  others. 

G.  There  is  no  reason  to  think  that,  year  in  and  year 
out,  railroads  would  obtain  higher  prices  for  their  securi- 
ties under  any  form  of  competitive  negotiating  or  bid- 
ding than  under  the  present  ])ractice.  There  is  every 
reason  to  think  that  the  stability  and  broad  receptive- 
ness  of  the  market  for  railroad  securities  would  be 
lessened  and  the  interests  of  the  investors  less  carefully 
and  responsibly  safeguarded. 

H.  Many,  if  not  all  of  the  effective  values  of  the  ad- 
vantages (both  to  the  railroads  and  to  the  investing  pub- 
lic)   inherent  in  the  present  practice,  would  be  elimi- 


55 


nated  by  competitive  negotiating  or  bidding,  whether 
unrestricted  or  confined  to  bankers.  No  banker  could 
be, expected  to  give  his  time,  effort,  reputation  and  re- 
sponsibihty,  material  and  moral,  to  the  financial  affairs 
of  a  corporation  if  he  is  wholly  uncertain  whether  he 
will  reap  any  return  for  his  services,  as  must  necessarily 
be  the  case  in  the  event  of  competitive  negotiating  or 
bidding. 

I.  To  change  the  prevailing  practice  would  mean  to 
give  up  definite  and  tested  benefits,  alike  to  the  railroads 
and  to  the  public,  for  the  sake  of  one  wholly  problem- 
atical advantage. 

J.  Practical  experience  shows  that  the  operation  of 
the  present  method  under  public  supervision  and  with 
full  publicity  attending  it,  assures  more  success  than  any 
other  plan  yet  proposed  or  practiced  in  obtaining  the 
necessary  capital  for  the  railroads  upon  favorable  terms, 

K.  To  the  extent  that  the  terms  upon  which  securi- 
ties are  sold  have  a  bearing  upon  the  rates  paid  by  the 
pubhc  for  railroad  service,  the  present  method  secures 
to  the  public,  insofar  as  that  item  is  concerned,  the  low- 
est burden  upon  the  rates  and  the  greatest  assurance  of 
the  railroads  being  able  to  obtain  the  capital  to  provide 
necessarj^  facilities. 


CONCLUSION 


To  compel  railroads  to  have  recourse  for  the  sale  of 
their  securities  to  competitive  negotiating  with  or  bid- 
ding on  the  part  of  bankers  and  brokers,  or  to  direct 
offerings  to  the  public,  would  be  to  run  counter  to  the 
practice  and  eocperience  of  every  country  in  the  world. 


56 


It  would  confuse  and  trouble  the  investing  public  and 
destroy  elements  and  features  of  evident  and  proved 
value  for  public  protection. 

It  would  tend'  to  make  the  possession  of  capital  the 
sole  requisite  for  dealing  in  securities,  irrespective  of 
skill,  care,  reputation  and  the  confidence  of  investors. 

It  would  limit,  hamper  and  restrain  the  flow  of  capital 
into  American  railroad  securities  and  cause  delay,  un- 
certainty, risk  and  damage  to  railroad  corporations. 

Railroads  and  other  corporations  should  be  left  free, 
under  the  responsibility  of  their  board  of  directors,  and 
subject  to  su^ch  authority  over  the  issue  of  their  securi- 
ties as  is  now  exercised  by  the  Interstate  Commerce 
Commission,  to  deal  with  whatever  banking  houses  they 
deem  it  in  their  best  interest  to  employ. 

They  shoidd  neither  be  bound  by  contract  or  control 
to  deal  rvith  any  one  banking  house  exclusively ,  nor  a 

forced  by  statute  or  regulation  to  take  the  chances  in- 
volved in  competitive  negotiating  or  bidding  among 
bankers  or  of  direct  dealing  with  the  jniblic. 


Respectfully  submitted, 

KUHN,  LoEB  &  Co. 

October  25,  1922. 


1 


"^^i/uam^yam/^ney. 


KU  h  N.  LOEB  &  CO. 


e€(.^-zy/orn     Nov.  27,  19 


Dear  Sir:- 

Believing  that  the  suhject  matter  may  pos- 
silDly  "be  of  interest  to  you,  we  "beg  to  enclose  here- 
with copy  of  a  memorandum  which  we  have  suhmitted  to 
the  Interstate  CoiEmerce  Commission  in  connection  with 
the  recent  hearing  "before  that  "oody  "in  the  matter  of 
terms  and  conditions  to  iDe  prescri"bed  hy  the  Commis- 
sion in  connection  with  the  issuance  of  securities 
under  section  20-a  of  the  Interstate  Commerce  Act, 
as  amended". 

Respectfully  yours, 
EUHN,  LOEB  &  CO. 


Enc.-M 


AHVHSil  SIOSDTtt  JD  AmmB 


3  0112059719598 


